# American Water Works Company, Inc.: Form 10-Q for the period ended Mar 31, 2014

- Company: [American Water Works Company, Inc.](/companies/awk.md) (CIK 1410636)
- Form: 10-Q
- Filed: 2014-05-07
- Accepted by EDGAR: May 7, 2014, 20:43 ET
- Period: 2014-03-31
- Accession: 0001564590-14-001874
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1410636/000156459014001874/awk-10q_20140331.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1410636/000156459014001874/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2014-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2014-01-01 to 2014-03-31 | $681.9m | us-gaap:Revenues |
| Operating income | 3 months, 2014-01-01 to 2014-03-31 | $186.1m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2014-01-01 to 2014-03-31 | $73.6m | us-gaap:InterestExpense |
| Income tax | 3 months, 2014-01-01 to 2014-03-31 | $44.9m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2014-01-01 to 2014-03-31 | $68.1m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2014-01-01 to 2014-03-31 | $0.38 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2014-01-01 to 2014-03-31 | $0.38 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2014-01-01 to 2014-03-31 | 179,457,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Capital expenditure | 3 months, 2014-01-01 to 2014-03-31 | $192.5m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 3 months, 2014-01-01 to 2014-03-31 | $50.0m | us-gaap:PaymentsOfDividendsCommonStock |
| Cash and equivalents | at 2014-03-31 | $30.8m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2014-03-31 | $688.0m | us-gaap:AssetsCurrent |
| Total assets | at 2014-03-31 | $15.27bn | us-gaap:Assets |
| Current liabilities | at 2014-03-31 | $1.20bn | us-gaap:LiabilitiesCurrent |
| Long-term debt | at 2014-03-31 | $5.21bn | us-gaap:LongTermDebtNoncurrent |
| Current portion of debt | at 2014-03-31 | $14.9m | us-gaap:LongTermDebtCurrent |
| Short-term borrowings | at 2014-03-31 | $638.2m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2014-03-31 | $4.80bn | us-gaap:StockholdersEquityIncludingPortionAttributableToNoncontrollingInterest |

## Management's discussion and analysis

As filed, 48,410 characters.

### FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements included in this Form 10-Q, other than statements of historical fact, may constitute forward-looking statements. Forward-looking statements can be identified by the use of words such as “may,” “should,” “will,” “could,” “estimates,” “predicts,” “potential,” “continue,” “anticipates,” “believes,” “plans,” “expects,” “future” and “intends” and similar expressions. Forward-looking statements may involve known and unknown risks, uncertainties and other factors that may cause the actual results or performance to differ from those projected in the forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. Factors that could cause or contribute to differences in results and outcomes from those in our forward-looking statements include, without limitation, those items discussed in the “Risk Factors” section or other sections in the Company’s annual report on Form 10-K (“Form 10-K”) for the year ended December 31, 2013 filed with the Securities and Exchange Commission (“SEC”), as well as in Item IA of Part II of this Quarterly Report. We undertake no obligation, other than as required by law, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

### General

American Water Works Company, Inc. (herein referred to as “American Water” or the “Company”) is the largest investor-owned United States water and wastewater utility company, as measured both by operating revenue and population served. Our primary business involves the ownership of water and wastewater utilities that provide water and wastewater services to residential, commercial, industrial and other customers. Our Regulated Businesses that provide these services are generally subject to economic regulation by state regulatory agencies (“PUCs”) in the states in which they operate. We report the results of these businesses in our Regulated Businesses segment. We also provide services that are not subject to economic regulation by the PUCs. We report the results of these businesses in our Market-Based Operations segment. For further description of our businesses see Item 1, “Business” section, found in our Form 10-K for the year ended December 31, 2013 filed with the SEC.

You should read the following discussion in conjunction with our Consolidated Financial Statements and related Notes included elsewhere in this Quarterly Report on Form 10-Q and in our Form 10-K for the year ended December 31, 2013 filed with the SEC.

### Overview

*Financial Results.* For the three months ended March 31, 2014, we reported net income of $68.1 million, or diluted earnings per share (“EPS”) of $0.38 compared to $57.6 million, or diluted EPS of $0.32 for the comparable period in 2013.

The primary factors contributing to the increase in net income for the three months ended March 31, 2014 compared to the same period in 2013 was increased revenues in our Regulated Business segment partially offset by higher operation and maintenance expense (“O&M”), also in our Regulated Businesses. For further details, see “Consolidated Results of Operations and Variances” and “Segment Results” below.

For 2014, our goals include actively addressing regulatory lag that impacts return on our investments and promoting constructive regulatory frameworks, continuing to improve our regulated O&M efficiency ratio, making efficient use of our capital and expanding both our Regulated Businesses segment through focused acquisitions and/or organic growth and our Market-Based Operations segment through core growth, expanding markets and new offerings. Also, in 2014, we anticipate savings from expense reductions attributable to lower business transformation project-related implementation costs, lower pension costs and lower interest expense resulting from our 2013 debt refinancing. In addition, we will continue to concentrate on our customers by achieving established customer satisfaction and service quality targets. Regarding environmental sustainability, we are committed to maximizing our protection of the environment, reducing our carbon and waste footprints and water lost through leakage.

We expect to resolve three rate proceedings during 2014 and plan to file up to four general rate cases, including one which was already filed in January 2014. Additionally, we will file for infrastructure surcharges, either as part of our general rate case filings or in separate filings, and continue to pursue appropriate pass-through mechanisms for certain costs and forward-looking adjustments or mechanisms, including those that recognize declining usage.

The progress that we have made in the first three months of 2014 with respect to certain of these objectives is described below.

*Addressing Regulatory Lag.* On January 1, 2014, our Pennsylvania rate case settlement, which was approved on December 19, 2013 and provides for $26.0 million in additional annualized revenue, became effective. Also, on January 1, 2014, additional annualized revenues of $0.9 million, $10.1 million and $2.1 million resulting from infrastructure charges in our New York, New Jersey and Illinois subsidiaries, respectively, became effective. Additionally, an environmental cost adjustment mechanism to pass through expenses and capital costs of mandated environmental compliance measures by a utility, which was previously approved by the Missouri Public Service Commission in April 2013, was adopted by our Missouri subsidiary on January 3, 2014, and became effective February 3, 2014.

Also, in January 2014, our New York subsidiary filed two infrastructure surcharges producing additional annualized revenue of approximately $0.7 million and $0.2 million which became effective on March 3, 2014 and April 1, 2014, respectively.

On January 24, 2014, we filed our general rate case in Indiana requesting additional annualized revenues of $19.6 million. On February 28, 2014, the Iowa Utilities Board issued a final order, authorizing additional annualized revenue of $3.8 million for our Iowa subsidiary. The new rates were effective on April 18, 2014. The increase includes approximately $2.7 million of interim rates that were effective May 10, 2013.

On February 25, 2014, our Missouri subsidiary filed for additional revenues from infrastructure charges in the amount of $3.1 million. The filing is expected to be effective during the second quarter of 2014.

On April 1, 2014, the final $1.2 million of annualized revenue rate increase, previously approved by the New York State Public Service Commission in March of 2012, became effective.

In October, 2013, our Tennessee subsidiary filed a petition with the Tennessee Regulatory Authority (“TRA”) that would allow four alternative rate mechanisms including a Qualified Infrastructure Investment Program Rider, an Economic Development Investment Rider, a Safety and Environmental Compliance Rider, and a Production Costs and Other Pass-through mechanism. On January 10, 2014, we filed with the TRA a settlement agreement that we entered into with the Consumer Advocate and Protection Division. The TRA approved both the rate mechanisms and settlement agreement with an effective date of April 15, 2014.

As of May 5, 2014, we are awaiting final orders for general rate cases in two states, requesting additional annualized revenue of approximately $52.0 million, including the Indiana case filed in January 2014. There is no assurance that all, or any portion, of these requested increases will be granted.

*Continuing Improvement in O&M Efficiency Ratio for our Regulated Businesses.* Our O&M efficiency ratio (a non-GAAP measure) is calculated on our Regulated Businesses’ operations and is defined as operation and maintenance expense divided by operating revenues where both O&M and operating revenues are adjusted to eliminate the impact of purchased water. We also exclude the allocable portion of non-O&M support services costs, mainly depreciation and general taxes that are reflected in the Regulated Businesses segment as O&M costs but for consolidated financial reporting purposes are categorized within other line items in the Statement of Operations. Our O&M efficiency ratio was 41.5% for the three months ended March 31, 2014, compared to 42.9% for the three months ended March 31, 2013. The change in our 2014 O&M efficiency ratio for the three months ended March 31, 2014 was primarily attributable to the increase in our Regulated Businesses’ revenue.

We evaluate our operating performance using this measure because management believes it is a direct measure of the efficiency of our Regulated Businesses’ operations. This information is intended to enhance an investor’s overall understanding of our operating performance. The O&M efficiency ratio is not a measure defined under GAAP and may not be comparable to other companies’ operating measures and should not be used in place of the GAAP information provided elsewhere in this report. The following table provides a reconciliation that compares O&M and operating revenues, as determined in accordance with GAAP, to those amounts utilized in the calculation of our O&M efficiency ratio for the three months ended March 31, 2014 as compared to the same period in 2013:

Regulated O&M Efficiency Ratio (a Non-GAAP Measure):

*(In thousands)*

|  | For the three months ended March 31, 2014 | 2013 |
| --- | ---: | ---: |
| Total O&M | $329,275 | $312,203 |
| Less: |  |  |
| O&M—Market-Based Operations | 65,840 | 59,224 |
| O&M—Other | (14,392) | (15,963) |
| Total Regulated O&M | 277,827 | 268,942 |
| Less: |  |  |
| Regulated purchased water expense | 27,082 | 23,984 |
| Allocation of internal O&M | 9,992 | 9,554 |
| Adjusted Regulated O&M(a) | $240,753 | $235,404 |
| Total Operating Revenues | $681,946 | $636,137 |
| Less: |  |  |
| Operating revenues—Market-Based Operations | 78,798 | 67,336 |
| Operating revenues—Other | (4,496) | (4,436) |
| Total Regulated operating revenues | 607,644 | 573,237 |
| Less: Regulated purchased water expense\* | 27,082 | 23,984 |
| Adjusted Regulated operating revenues(b) | $580,562 | $549,253 |
| Regulated O&M efficiency ratio (a)/(b) | 41.5% | 42.9% |

\* Calculation assumes purchased water revenues are equal to purchased water expenses.

*Making Efficient Use of Capital.* We made capital investments of approximately $175.2 million during the three months ended March 31, 2014. Of this total investment, approximately $173.0 million was for Company-funded capital improvements with the remaining $2.2 million for the acquisition of regulated water and/or wastewater systems. For the full-year of 2014, we continue to estimate our total capital plan to be approximately $1.1 billion, with approximately $900 million to $1.0 billion allocated to upgrading our infrastructure and systems and $100 million for acquisitions and strategic investment purposes.

*Expanding Markets and Developing New Offerings.* During the three months ended March 31, 2014, our Regulated Businesses completed the purchase of a regulated water system and another regulated system with both water and wastewater services. These acquisitions added approximately 900 customers to our regulated operations. Also, as previously announced, in January 2014, our Military Services Group, within our Market-Based Operations was awarded a contract for ownership, operation and maintenance of the water and wastewater systems at Hill Air Force Base in Utah and our Homeowner Services Group (“HOS”) expanded its water and sewer line protection programs into Maine, Minnesota and Oklahoma.

#### Other Matters.

*West Virginia Freedom Industries Chemical Spill.* As noted in the Form 10-K, on January 9, 2014, a chemical storage tank owned by Freedom Industries, Inc. leaked two substances, 4-methylcyclohexane methanol, or MCHM, and PPH, a mix of polyglycol ethers, into the Elk River near the West Virginia-American Water Company (“WVAWC”) treatment plant in Charleston, West Virginia. As a result of this event, income before income taxes was reduced by $5.9 million for the three months ended March 31, 2014.

As disclosed in more detail in Part II, Item 1, “Legal Proceedings” in this 10-Q to date, 58 lawsuits have been filed against WVAWC with respect to this matter in the United States District Court for the Southern District of West Virginia or West Virginia Circuit Courts in Kanawha, Boone, and Putman counties. (The state court cases have been removed to federal court and are subject to remand motions.) Many of these lawsuits also name Freedom Industries (which is now in bankruptcy), and a few also name the Company or other Company affiliates.

The Company and WVAWC believe that WVAWC has responded appropriately to, and has no responsibility for, the Freedom Industries spill and the Company, WVAWC and other Company-affiliated entities named in any of the lawsuits have valid, meritorious defenses to the lawsuits. The Company, WVAWC and the other Company affiliates intend to vigorously contest the lawsuits. Nevertheless, an adverse outcome in one or more of the lawsuits could have a material adverse effect on the Company's financial condition, results of operations, cash flows, liquidity and reputation. Moreover, WVAWC and the Company are unable to predict the outcome of the ongoing government investigations or any legislative initiatives that might affect water utility operations.

### Consolidated Results of Operations and Variances

|  | Three Months Ended March 31, 2014 | 2013 | Favorable (Unfavorable) Change |
| --- | ---: | ---: | ---: |
| Operating revenues | $681,946 | $636,137 | $45,809 |
| Operating expenses |  |  |  |
| Operation and maintenance | 329,275 | 312,203 | (17,072) |
| Depreciation and amortization | 106,078 | 99,649 | (6,429) |
| General taxes | 60,767 | 60,146 | (621) |
| (Gain) loss on asset dispositions and purchases | (270) | (94) | 176 |
| Total operating expenses, net | 495,850 | 471,904 | (23,946) |
| Operating income | 186,096 | 164,233 | 21,863 |
| Other income (expenses) |  |  |  |
| Interest, net | (73,560) | (78,114) | 4,554 |
| Allowance for other funds used during construction | 2,201 | 3,396 | (1,195) |
| Allowance for borrowed funds used during construction | 1,483 | 1,653 | (170) |
| Amortization of debt expense | (1,673) | (1,581) | (92) |
| Other, net | (1,541) | (776) | (765) |
| Total other income (expenses) | (73,090) | (75,422) | 2,332 |
| Income before income taxes | 113,006 | 88,811 | 24,195 |
| Provision for income taxes | 44,883 | 31,168 | (13,715) |
| Net income | $68,123 | $57,643 | $10,480 |
| Income per common share |  |  |  |
| Basic | $0.38 | $0.32 |  |
| Diluted | $0.38 | $0.32 |  |
| Average common shares outstanding during the period |  |  |  |
| Basic | 178,539 | 177,327 |  |
| Diluted | 179,457 | 178,465 |  |

The following is a discussion of the consolidated results of operations for the three months ended March 31, 2014 compared to the three months ended March 31, 2013:

#### Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013

***Operating revenues.*** Consolidated operating revenues for the three months ended March 31, 2014 increased $45.8 million, or 7.2%, compared to the same period in 2013. The increase is the result of higher revenues in our Regulated Businesses segment of $34.4 million, which is mainly attributable to rate increases, incremental revenues from surcharges and amortization of balancing accounts as well as increased usage. Also, contributing to the higher revenues was an $11.5 million increase in our Market-Based Operations segment primarily due to incremental revenue from our military contracts as a result of increased construction type projects at Fort Meade and Belvoir as well as contract growth in our Homeowner Services Group (“HOS”). For further information, see the respective “Operating Revenues” discussions within the “Segment Results.”

***Operation and maintenance.*** Consolidated O&M for the three months ended March 31, 2014 increased by $17.1 million, or 5.5%, compared to the same period in 2013. The variance is primarily due to higher O&M costs in our Regulated Businesses segment of $8.9 million, principally due to increased production costs and in our Market-Based segment of $6.6 million mainly as a result of incremental cost related to increased activity in our military contracts, corresponding with the increased revenue. For further discussions on the changes in our Regulated and Market-Based segments’ O&M, see the respective “Operation and Maintenance” discussions within the “Segment Results.”

***Depreciation and amortization.*** Depreciation and amortization expense increased by $6.4 million, or 6.5%, for the three months ended March 31, 2014, compared to the same period in the prior year principally as a result of additional utility plant placed in service, including Phase II of our business transformation project that went into service during the second and fourth quarters of 2013.

***Other income (expenses).*** Other expenses decreased by $2.3 million, or 3.1%, for the three months ended March 31, 2014, compared to the same period in the prior year. The change is primarily due to a reduction in interest expense resulting from interest savings as a result of our 2013 refinancings, offset by a reduction in AFUDC which is mainly attributable to Phase II of our business transformation project being placed into service in the second and fourth quarters of 2013.

***Provision for income taxes.*** Our consolidated provision for income taxes increased $13.7 million, or 44.0%, to $44.9 million for the three months ended March 31, 2014. The effective tax rates for the three months ended March 31, 2014 and 2013 were 39.7% and 35.1%, respectively. The 2013 rate included a $3.3 million tax benefit associated with a legal structure reorganization in our Market-Based segment. This strategic restructuring allows us to utilize state net operating loss carryforwards, which without the restructuring most likely would not have been utilized prior to their expiration.

### Segment Results

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

### Regulated Businesses Segment

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

*(In thousands)*

|  | For the three months ended March 31, 2014 | 2013 | Increase (Decrease) |
| --- | ---: | ---: | ---: |
| Operating revenues | $607,644 | $573,237 | $34,407 |
| Operation and maintenance expense | 277,827 | 268,942 | 8,885 |
| Operating expenses, net | 431,957 | 415,516 | 16,441 |
| Income before income taxes | 115,028 | 98,781 | 16,247 |

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

Operating revenues increased by $34.4 million, or 6.0%, for the three months ended March 31, 2014, as compared to the same period in 2013. The increase in revenues is principally due to incremental revenues of approximately $19.8 million attributable to rate increases from rate authorizations for a number of our operating companies and higher consumption which increased revenues by approximately $5.8 million. Additionally revenues were higher by $5.3 million due to increased surcharge and amortization of balancing accounts. Lastly, revenues increased by $3.3 million as a result of 2013 acquisitions, with the most significant being the acquisition of Dale Service Corporation (“Dale”) by our Virginia subsidiary in the fourth quarter of 2013.

The following table provides information regarding the Regulated Businesses’ for the periods indicated:

| Customer Class Water service | For the three months ended March 31, 2014 Operating Revenues (dollars in thousands) | 2013 | Increase (Decrease) | Percentage | 2014 Billed Water Sales Volume (gallons in millions) | 2013 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Residential | $353,524 | $326,142 | $27,382 | 8.4% | 39,937 | 37,988 | 1,949 | 5.1% |
| Commercial | 129,819 | 114,074 | 15,745 | 13.8% | 18,989 | 16,922 | 2,067 | 12.2% |
| Industrial | 33,569 | 28,201 | 5,368 | 19.0% | 9,815 | 8,883 | 932 | 10.5% |
| Public and other | 83,966 | 73,953 | 10,013 | 13.5% | 13,409 | 11,627 | 1,782 | 15.3% |
| Other water revenues | 777 | 5,134 | (4,357) | (84.9%) | — | — | — | — |
| Billed water services | 601,655 | 547,504 | 54,151 | 9.9% | 82,150 | 75,420 | 6,730 | 8.9% |
| Unbilled water services | (26,207) | (5,460) | (20,747) | 380.0% |  |  |  |  |
| Total water service revenues | 575,448 | 542,044 | 33,404 | 6.2% |  |  |  |  |
| Wastewater service revenues | 22,408 | 19,884 | 2,524 | 12.7% |  |  |  |  |
| Other revenues | 9,788 | 11,309 | (1,521) | (13.4%) |  |  |  |  |
|  | $607,644 | $573,237 | $34,407 | 6.0% |  |  |  |  |

*Water Services –* Water service operating revenues for the three months ended March 31, 2014 totaled $575.4 million, a $33.4 million increase, or 6.2%, over the same period of 2013. As described above, this increase is primarily due to rate increases, higher consumption and incremental revenues associated with surcharges and amortization of balancing accounts. Also, it should be noted that the mix between billed revenues and unbilled revenues for the three months ended March 31, 2014, as compared to the same period in 2013, has changed. This change is principally the result of the implementation of our Customer Information System “CIS” as part of Phase II of our business transformation project. At December 31, 2013, unbilled revenues were significantly higher than historical levels due to billing delays in certain accounts. During the first quarter of 2014, we have addressed a majority of these delayed billings. Therefore, as a result, the change in unbilled water revenue for the first quarter of 2014 compared to the same period in 2013 has decreased by $20.7 million with a corresponding increase in billed revenues.

*Wastewater services –* Our subsidiaries provide wastewater services in ten states. Revenues from these services increased $2.5 million, or 12.7%, for the three months ended March 31, 2014, compared to the same period in 2013. The increase is primarily attributable to the Dale acquisition in the fourth quarter of 2013.

***Operation and maintenance expense.*** Operation and maintenance expense increased $8.9 million, or 3.3%, for the three months ended March 31, 2014, compared to the same period in 2013.

The following table provides information regarding operation and maintenance expense for the three months ended March 31, 2014 and 2013, by major expense category:

*(Dollars in thousands)*

|  | For the three months ended March 31, 2014 | 2013 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Production costs | $69,259 | $60,450 | $8,809 | 14.6% |
| Employee-related costs | 107,181 | 113,201 | (6,020) | (5.3%) |
| Operating supplies and services | 56,265 | 54,360 | 1,905 | 3.5% |
| Maintenance materials and supplies | 20,447 | 18,279 | 2,168 | 11.9% |
| Customer billing and accounting | 13,205 | 10,172 | 3,033 | 29.8% |
| Other | 11,470 | 12,480 | (1,010) | (8.1%) |
| Total | $277,827 | $268,942 | $8,885 | 3.3% |

26

Production costs by major expense type were as follows:

*(Dollars in thousands)*

|  | For the three months ended March 31, 2014 | 2013 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Purchased Water | $27,082 | $23,984 | $3,098 | 12.9% |
| Fuel and Power | 23,918 | 19,978 | 3,940 | 19.7% |
| Chemicals | 10,668 | 10,604 | 64 | 0.6% |
| Waste Disposal | 7,591 | 5,884 | 1,707 | 29.0% |
| Total | $69,259 | $60,450 | $8,809 | 14.6% |

Production costs increased overall by $8.8 million, or 14.6%, for the three months ended March 31, 2014, compared to the same period in the prior year. The higher costs are mainly due to incremental purchased water costs, principally due to price increases in our California subsidiary and higher fuel and power costs due to increased customer demand and higher supplier prices in several of our operating facilities.

Employee-related costs, including salaries and wages, group insurance and pension expense, decreased $6.0 million, or 5.3%, for the three months ended March 31, 2014, compared to the same period in the prior year. These employee-related costs represent approximately 39% and 42% of operation and maintenance expense for the three months ended March 31, 2014 and 2013, respectively.

The following table provides information with respect to components of employee-related costs for the three months ended March 31, 2014 and 2013:

*(Dollars in thousands)*

|  | For the three months ended March 31, 2014 | 2013 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Salaries and wages | $81,083 | $78,845 | $2,238 | 2.8% |
| Pensions | 6,820 | 12,371 | (5,551) | (44.9%) |
| Group insurance | 14,365 | 16,844 | (2,479) | (14.7%) |
| Other benefits | 4,913 | 5,141 | (228) | (4.4%) |
| Total | $107,181 | $113,201 | $(6,020) | (5.3%) |

The overall decrease in employee-related costs for the three months ended March 31, 2014, compared to the same period in 2013, was primarily due to a reduction in pension and group insurance expenses, with the primary driver of group insurance being postretirement benefit costs. These decreases are principally due to the change in the discount rate, which in turn results in decreased contributions, in particular in certain of our regulated operating companies whose costs are recovered based on our funding policy, which is to fund at least the minimum amount required by the Employee Retirement Income Security Act of 1974. Partially offsetting these decreases was an increase in salaries and wages expense for the three months ended March 31, 2014, compared to the same period in 2013. This increase is the result of annual wage increases and increased overtime expense attributable to increased number of main breaks as a result of the harsh winter weather conditions, offset by a reduction in incentive compensation expense due to a lower than expected 2013 incentive compensation payout as well as higher capitalization rates as a result of increased capital projects.

Operating supplies and services include the day-to-day expenses of office operation, legal and other professional services, transportation expenses, information systems rental charges and other office equipment rental charges. These costs increased $1.9 million, or 3.5%, for the three months ended March 31, 2014. The overall increase was primarily due to increased legal costs for our West Virginia subsidiary associated with the Freedom Industries Chemical Spill which occurred in January 2014. Partially offsetting the increase in costs was lower contracted service in the first quarter of 2014 compared to 2013. This decrease was the result of the inclusion in 2013 of additional costs, mainly as a result of backfilling positions; the use of contractors for certain projects; and incremental costs attributable to the continued maturity of our Enterprise Resource Planning systems in conjunction with the implementation of our business transformation project.

Maintenance materials and supplies, which include emergency repairs as well as costs for preventive maintenance, increased $2.2 million, or 11.9%, for the three months ended March 31, 2014, compared to the same period in 2013 mainly due to an increase in paving and backfilling and other repair costs resulting from the higher number of main breaks due to abnormally harsh winter weather conditions throughout our operating areas.

Customer billing and accounting expenses, which include uncollectible accounts expense, postage and other customer related expenses, increased $3.0 million, or 29.8%, for the three months ended March 31, 2014, respectively, compared to the same period in the prior year. This increase is primarily due to incremental uncollectible expense associated with an increase in customer accounts receivable attributable to theoverall aging of receivables as well as rate increases. We believe the aging of our receivables is the result of temporary changes made in our collection process with the implementation of our new Customer Information System in 2013.

Other operation and maintenance expense includes casualty and liability insurance premiums and regulatory costs. The decrease in these costs for the three months ended March 31, 2014, was primarily driven by lower regulatory expenses in one of our operating subsidiaries compared to the same period in the prior year.

***Operating expenses.*** The increase in operating expenses, for the three months ended March 31, 2014, is principally due to the increase in operation and maintenance expense explained above and higher depreciation and amortization expense of $6.9 million. The increase in depreciation and amortization is primarily due to additional utility plant placed in service, including Phase II of our business transformation project.

### Market-Based Operations

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

*(In thousands)*

|  | For the three months ended March 31, 2014 | 2013 | Increase (Decrease) |
| --- | ---: | ---: | ---: |
| Operating revenues | $78,798 | $67,336 | $11,462 |
| Operation and maintenance expense | 65,840 | 59,224 | 6,616 |
| Operating expenses, net | 68,812 | 62,381 | 6,431 |
| Income before income taxes | 10,631 | 5,671 | 4,960 |

***Operating revenues.*** Revenues for the three months ended March 31, 2014 increased $11.5 million, compared to the same period in 2013, due to incremental revenues in our Contract Operations Group of $7.6 million and HOS of $5.3 million due to contract growth mainly with our New York City contracts. The increase in the Contract Operations Group is primarily related to additional revenues from capital project activities associated with our military contracts partially offset by a reduction in revenues attributable to terminated municipal and industrial operations and maintenance contracts in 2013.

***Operation and maintenance.*** Operation and maintenance expense increased $6.6 million, or 11.2%, for the three months ended March 31, 2014.

The following table provides information regarding categories of operation and maintenance expense for the three months ended March 31, 2014 and 2013:

*(Dollars in thousands)*

|  | For the three months ended March 31, 2014 | 2013 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Production costs | $9,974 | $10,059 | $(85) | (0.8%) |
| Employee-related costs | 14,566 | 16,331 | (1,765) | (10.8%) |
| Operating supplies and services | 27,779 | 21,470 | 6,309 | 29.4% |
| Maintenance materials and supplies | 11,503 | 10,586 | 917 | 8.7% |
| Other | 2,018 | 778 | 1,240 | 159.4% |
| Total | $65,840 | $59,224 | $6,616 | 11.2% |

As noted in the table above, the primary factor contributing to the overall increase was an increase in operating supplies and services. This increase is attributable to the increase in construction project activities for our military contracts and corresponds with the incremental revenues.

***Operating expense.*** The changes in operating expenses for the three months ended March 31, 2014, compared to the same period in 2013, are primarily due to the variances in the operation and maintenance expense explained above.

### Liquidity and Capital Resources

For a general overview of our sources and uses of capital resources, see the introductory discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources,” contained in part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2013.

We rely on our revolving credit facility, the capital markets and our cash flows from operations to fulfill our short-term liquidity needs, to issue letters of credit and to support our commercial paper program. We fund liquidity needs for capital investment, working capital and other financial commitments through cash flows from operations, public and private debt offerings, commercial paper markets and to the extent necessary, our revolving credit facility. We regularly evaluate the capital markets and closely monitor the financial condition of the financial institutions with contractual commitments in the revolving credit facility.

In order to meet our short-term liquidity needs, we, through AWCC, our financing subsidiary, issue commercial paper, which is supported by the revolving credit facility. The revolving credit facility is also used, to a limited extent, to support our issuance of letters of credit and from time to time, for direct borrowings. As of March 31, 2014, AWCC had no outstanding borrowings and $41.0 million of outstanding letters of credit under the revolving credit facility. As of March 31, 2014, AWCC had $1.2 billion available under the credit facility that we can use to fulfill our short-term liquidity needs, to issue letters of credit and support our $638.2 million outstanding commercial paper. We can provide no assurances that our lenders will meet their existing commitments or that we will be able to access the commercial paper or loan markets in the future on terms acceptable to us or at all.

### Cash Flows from Operating Activities

Cash flows from operating activities primarily result from the sale of water and wastewater services and, due to the seasonality of demand, are generally greater during the third quarter of each fiscal year. Cash flows from operating activities for the three months ended March 31, 2014 were $244.9 million compared to $149.6 million for the three months ended March 31, 2013.

The following table provides a summary of the major items affecting our cash flows from operating activities for the three months ended March 31, 2014 and 2013:

*(In thousands)*

|  | Three Months Ended March 31, 2014 | 2013 |
| --- | ---: | ---: |
| Net income | $68,123 | $57,643 |
| Add (subtract): |  |  |
| Non-cash activities (1) | 174,110 | 141,670 |
| Changes in working capital (2) | 13,355 | (19,922) |
| Pension and postretirement healthcare contributions | (10,714) | (29,766) |
| Net cash flows provided by operations | $244,874 | $149,625 |

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

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

Our working capital needs are primarily limited to funding the increase in our customer accounts receivable and unbilled revenues which is mainly associated with the revenue increase as a result of rate increases in our Regulated Businesses. We address this timing issue through the aforementioned liquidity funding mechanisms. Our cash collections for our Regulated Businesses’ accounts receivable, some of which were unbilled as December 31, 2013, showed improvement during the first quarter of 2014 compared to the second half of 2013. In the second half of 2013, the rate of cash collections in particular in those states in which we implemented CIS in the second quarter of 2013, were slower than historical payment patterns. We believe this degradation in cash collections to be as a result of certain implementation decisions, made as part of the CIS implementation, including such items as the manual validation of bills prior to being mailed to customers and decreased collection efforts. Therefore, we believe this situation to be only temporary in nature. Although cash collections increased during the first quarter of 2014, there are no assurances that this rate of cash collections will continue or be consistent with previous historical collection patterns.

The increase in cash flows from operating activities was primarily due to higher net income adjusted for non-cash activities, the changes in working capital and a reduction in pension and postretirement benefit contributions. The increase in working capital for the three months ended March 31, 2014 compared to the same period in the prior year is principally the result of increased processing of payments, accounts payable and accrued expenses, in the first quarter of 2013, which was attributed to delays in payment of vendor invoices in the latter portion of 2012 as a result of the implementation of Phase I of our business transformation project.

### Cash Flows from Investing Activities

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

*(In thousands)*

|  | Three Months Ended March 31, 2014 | 2013 |
| --- | ---: | ---: |
| Net capital expenditures | $(192,466) | $(213,086) |
| Proceeds from sale of assets | 243 | 280 |
| Acquisitions | (2,279) | (2,836) |
| Other investing activities, net (1) | (10,698) | (12,068) |
| Net cash flows used in investing activities | $(205,200) | $(227,710) |

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

Cash flows used in investing activities for the three months ended March 31, 2014 was $205.2 million compared to $227.7 million for the three months ended March 31, 2013. The decrease in net capital expenditures is primarily due to the inclusion in 2013 of capital spending for our business transformation project.

### Cash Flows from Financing Activities

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

As previously noted AWCC is a wholly-owned finance subsidiary of American Water Works Company, Inc. (the “parent company”). Based on the needs of our regulated subsidiaries and the parent company, AWCC borrows in the capital markets and then, through intercompany loans, provides those borrowings to the regulated subsidiaries and the parent company. The regulated subsidiaries and the parent company are obligated to pay their portion of the respective principal and interest to AWCC in the amount necessary to enable AWCC to meet its debt service obligations. Because the parent company borrowings are not a source of capital for the Company’s regulated subsidiaries, the Company is not able to recover the interest charges on parent company debt through regulated water and wastewater rates.

Our intent is to utilize commercial paper for short-term liquidity as commercial paper borrowings have historically been more flexible and a lower cost option. However, if necessary we utilize our credit facility to complement our borrowings in the commercial paper market. Certain disruptions in the money market sector of the debt capital markets may make borrowings under our revolving credit facility more efficient and/or a lower cost alternative to commercial paper.

No long-term debt was issued during the first three months of 2014.

The following long-term debt was retired through optional redemption, sinking fund provisions or payment at maturity during the first three months of 2014:

| Company | Type | Interest Rate | Maturity | Amount |
| --- | --- | ---: | --- | ---: |
| American Water Capital Corp. | Senior notes - fixed rate | 6.00% | 2039 | $4 |
| Other subsidiaries | Private activity bonds and government funded debt -fixed rate | 0.00%-5.25% | 2014-2041 | 2,181 |
| Other subsidiaries | Mandatorily redeemable preferred stock | 8.49% | 2036 | 1,200 |
| Other subsidiaries | Capital lease payments |  |  | 7 |
| Total retirements and redemptions |  |  |  | $3,392 |

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

### Credit Facilities and Short-Term Debt

Short-term debt balance, consisting of commercial paper, net of discount, amounted to $638.2 million at March 31, 2014.

The following table provides information as of March 31, 2014 regarding letters of credit sub-limits under our revolving credit facility and available funds under the revolving credit facility, as well as outstanding amounts of commercial paper and borrowings under our revolving credit facility.

*(In thousands)*

|  | Credit Facility Commitment | Available Credit Facility Capacity | Letter of Credit Sub-limit | Available Letter of Credit Capacity | Outstanding Commercial Paper (Net of Discount) | Credit Line Borrowings |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| March 31, 2014 | $1,250,000 | $1,208,954 | $150,000 | $108,954 | $638,227 | $- |

The weighted-average interest rate on short-term borrowings for the three months ended March 31, 2014 and 2013 was approximately 0.32% and 0.41%, respectively.

### Capital Structure

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

|  | At March 31, 2014 | At December 31, 2013 |
| --- | ---: | ---: |
| Total common stockholders' equity | 45% | 45% |
| Long-term debt and redeemable preferred stock at redemption value | 49% | 49% |
| Short-term debt and current portion of long-term debt | 6% | 6% |
|  | 100% | 100% |

### Debt Covenants

Our debt agreements contain financial and non-financial covenants. To the extent that we are not in compliance, we, or our subsidiaries, may be restricted in the ability to pay dividends, issue new debt or access our revolving credit facility. We were in compliance with our covenants as of March 31, 2014. As of April 30, 2014, two of our smaller operating companies are in technical non-compliance with certain of their reporting requirements. However, there is no impact on their financial health or their ability to access capital. Our failure to comply with restrictive covenants under our credit facility could accelerate repayment obligations. Our long-term debt indentures contain a number of covenants that, among other things, limit the Company from issuing debt secured by the Company’s assets, subject to certain exceptions.

Certain long-term notes and the revolving credit facility require us to maintain a ratio of consolidated debt to consolidated capitalization of not more than 0.70 to 1.00. As of March 31, 2014, our ratio was 0.55 to 1.00 and therefore we were in compliance with the covenant.

### Security Ratings

Our access to the capital markets, including the commercial paper market, and respective financing costs in those markets, is directly affected by securities ratings of the entity that is accessing the capital markets. We primarily access the capital markets, including the commercial paper market, through AWCC. However, we 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 shows the Company’s securities ratings as of March 31, 2014:

| Securities | Moody’s Investors Service | Standard & Poor’s Ratings Service |
| --- | --- | --- |
| Senior unsecured debt | Baa1 | A‑ |
| Commercial paper | P2 | A2 |

A security rating is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating agency, and each rating should be evaluated independently of any other rating. Security ratings are highly dependent upon our ability to generate cash flows in an amount sufficient 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.

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

### Dividends

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

On March 3, 2014, we made a cash dividend payment of $0.28 per share to all shareholders of record as of February 3, 2014. In order to take advantage of existing 2012 tax rates, the cash dividend payment that would have historically been paid in March 2013 was paid in December 2012.

On April 29, 2014 our board of directors declared a quarterly cash dividend payment of $0.31 per share payable on June 2, 2014 to all shareholders of record as of May 12, 2014.

### Market Risk

There have been no significant changes to our market risk since December 31, 2013. For a discussion of our exposure to market risk, refer to Part II, Item 7A. “Quantitative and Qualitative Disclosures about Market Risk,” contained in our Annual Report on Form 10-K for the year ended December 31, 2013.

### Application of Critical Accounting Policies and Estimates

Our financial condition, results of operations and cash flows are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates,” in our Form 10-K for the year ended December 31, 2013 filed with the SEC for a discussion of our critical accounting policies.

### Recent Accounting Pronouncements

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

## Market risk

As filed, 283 characters.

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

## Controls and procedures

As filed, 1,993 characters.

### Evaluation of Disclosure Controls and Procedures

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

Our management, including the Chief Executive Officer and the Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) of the Exchange Act) as of March 31, 2014 pursuant to 15d-15(e) under the Exchange Act.

Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2014, our disclosure controls and procedures were effective at a reasonable level of assurance. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

### Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the three months ended March 31, 2014, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

## Risk factors

As filed, 472 characters.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in the “Risk Factors” in the Company’s Form 10-K for the year ended December 31, 2013, and our other public filings, which could materially affect our business, financial condition or future results. There have been no material changes from risk factors previously disclosed in “Risk Factors” in the Company’s Form 10-K for the year ended December 31, 2013.

Filed May 7, 2014.
Source: SEC EDGAR, the filing index for accession 0001564590-14-001874. Last ingested by Listed: Nov 6, 2026, 17:16 ET. No prices; not investment advice.