# American Water Works Company, Inc.: Form 10-Q for the period ended Sep 30, 2014

- Company: [American Water Works Company, Inc.](/companies/awk.md) (CIK 1410636)
- Form: 10-Q
- Filed: 2014-11-05
- Accepted by EDGAR: Nov 5, 2014, 21:59 ET
- Period: 2014-09-30
- Accession: 0001564590-14-005041
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1410636/000156459014005041/awk-10q_20140930.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1410636/000156459014005041/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2014-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2014-07-01 to 2014-09-30 | $846.2m | us-gaap:Revenues |
| Revenue | 9 months, 2014-01-01 to 2014-09-30 | $2.28bn | us-gaap:Revenues |
| Operating income | 3 months, 2014-07-01 to 2014-09-30 | $337.3m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2014-01-01 to 2014-09-30 | $779.5m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2014-07-01 to 2014-09-30 | $75.4m | us-gaap:InterestExpense |
| Interest expense | 9 months, 2014-01-01 to 2014-09-30 | $222.7m | us-gaap:InterestExpense |
| Income tax | 3 months, 2014-07-01 to 2014-09-30 | $107.2m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2014-01-01 to 2014-09-30 | $224.8m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2014-07-01 to 2014-09-30 | $152.2m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2014-01-01 to 2014-09-30 | $329.6m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2014-07-01 to 2014-09-30 | $0.85 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2014-01-01 to 2014-09-30 | $1.83 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2014-07-01 to 2014-09-30 | $0.85 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2014-01-01 to 2014-09-30 | $1.84 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2014-07-01 to 2014-09-30 | 179,948,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2014-01-01 to 2014-09-30 | 179,723,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2014-01-01 to 2014-09-30 | $840.3m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Dividends paid | 9 months, 2014-01-01 to 2014-09-30 | $160.8m | us-gaap:PaymentsOfDividendsCommonStock |
| Cash and equivalents | at 2014-09-30 | $74.1m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2014-09-30 | $757.0m | us-gaap:AssetsCurrent |
| Total assets | at 2014-09-30 | $15.72bn | us-gaap:Assets |
| Current liabilities | at 2014-09-30 | $1.06bn | us-gaap:LiabilitiesCurrent |
| Long-term debt | at 2014-09-30 | $5.54bn | us-gaap:LongTermDebtNoncurrent |
| Current portion of debt | at 2014-09-30 | $55.6m | us-gaap:LongTermDebtCurrent |
| Short-term borrowings | at 2014-09-30 | $314.0m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2014-09-30 | $4.92bn | us-gaap:StockholdersEquityIncludingPortionAttributableToNoncontrollingInterest |

## Management's discussion and analysis

As filed, 66,853 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”). 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,” in our Form 10-K for the year ended December 31, 2013.

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.

### Overview

*Financial Results.* For the three months ended September 30, 2014, we reported net income of $152.2 million, or diluted earnings per share (“EPS”) of $0.85, compared to $150.7 million, or diluted EPS of $0.84, for the comparable period in 2013. Income from continuing operations was $156.6 million, or $0.87 per diluted share for the third quarter of 2014 compared to $149.9 million, or $0.84 per diluted share for the third quarter of 2013.

For the nine months ended September 30, 2014, we reported net income of $329.6 million, or diluted EPS of $1.83 compared to $309.6 million, or diluted EPS of $1.73, for the comparable period in 2013. Income from continuing operations was $335.9 million, or $1.87 per diluted share for the nine months ended September 30, 2014 compared to $309.7 million, or $1.73 per diluted share for the nine months ended September 30, 2013.

The increase in income from continuing operations for the three months ended September 30, 2014 compared to the same period in 2013 was due to favorable operating results from our Regulated Business segment due to higher revenues and lower operating expenses, partially offset by milder weather in the third quarter of 2014 compared to last year and the 2013 impact of retroactive price redeterminations for one of our military contracts in the Market-Based Operations. The increase in income from continuing operations for the nine months ended September 30, 2014 compared to the same period in 2013 was the result of favorable operating results from our Regulated Business segment reflecting higher revenue and lower operations and maintenance (“O&M”) expenses partially offset by higher depreciation expenses and higher costs resulting from the Freedom Industries chemical spill in West Virginia. Also contributing to the overall increase in income from continuing operations was lower interest expense for the both the three and nine month periods ended September 30, 2014 compared to the same periods in the prior year.

During the third quarter of 2014, management was involved in discussions to sell our Terratec line of business, which is part of our Market-Based Operations segment. The sale is expected to close in the fourth quarter of 2014. The financial results of this entity have been reflected as discontinued operations for all periods presented. All financial information in this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) reflects continuing operations, unless otherwise noted.

For 2014, our goals include actively addressing regulatory lag and promoting constructive regulatory frameworks, continuing to improve our regulated operation and maintenance (“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. In addition, we will continue to focus on our customer service 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. The progress that we have made in the nine months of 2014 with respect to certain of these objectives is described below.

*Promoting Constructive Regulatory Frameworks.* On July 1, 2014, annualized revenues of $7.4 million resulting from infrastructure charges in our New Jersey subsidiary became effective.

In July 2014, a settlement with the Office of Ratepayer Advocates and other interveners was reached in our general rate case in California. The settlement, if approved, would provide $13.6 million in additional annualized revenues for 2015. The settlement also provides for escalation and attrition adjustments in 2016 and 2017 of $5.0 million and $6.3 million, respectively. The agreement is pending regulatory approval and is subject to change.

On September 2, 2014, our Missouri subsidiary filed for additional annualized revenues from infrastructure charges in the amount of $8.5 million.

The table below provides further details of annualized revenues, assuming a constant volume, resulting from rate authorizations granted in 2014:

*(In millions)*

| State General Rate Cases | Annualized Rate Increases Granted For the three months ended September 30, 2014 | For the nine months ended September 30, 2014 |
| --- | ---: | ---: |
| New York | $— | $1.2 |
| Iowa | — | 3.8 |
| Total General Rate cases | $— | $5.0 |
| Infrastructure charges |  |  |
| New York | $— | $1.8 |
| New Jersey | 7.4 | 17.5 |
| Missouri | — | 3.7 |
| Illinois | — | 2.1 |
| Tennessee | — | 0.5 |
| Total Infrastructure charges | $7.4 | $25.6 |

On October 29, 2014, our Tennessee subsidiary filed for additional annualized revenue from infrastructure charges in the amount of $2.6 million.

As of October 31, 2014, we are awaiting final orders for general rate cases in Indiana and California, requesting additional annualized revenue of approximately $44.5 million, adjusted for the potential California settlement discussed above. There is no assurance that all or any portion, of these requests will be granted.

On October 22, 2014, the New Jersey Board of Public Utilities issued an order on the Consolidated Tax Adjustment (“CTA”) in New Jersey. Historically, the CTA allocated a portion of our consolidated losses since 1991 as a reduction to utility rate base. The order reaffirmed the continued use of a CTA as a deduction to utility rate base; however, it approved changes in methodology, two of which are significant for our New Jersey subsidiary. First, the "look-back" period was limited to the most recent five calendar years rather than to 1991. Second, the consolidated losses will be allocated 25% to customers and 75% to the company rather than customers receiving 100% allocation. The Order is subject to a 45 day appeal period.

*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 32.6% for the three months ended September 30, 2014, compared to 35.3% for the three months ended September 30, 2013. Our O&M efficiency ratio was 36.9% for the nine months ended September 30, 2014, compared to 38.5% for the nine months ended September 30, 2013. The improvement in our 2014 O&M efficiency ratio for the three months ended September 30, 2014 was primarily attributable to an increase in Regulated Businesses’ revenue and a decrease in our Regulated Businesses O&M compared to the same period in 2013. For the nine months ended September 30, 2014, the improvement was primarily attributable to the increase in our Regulated Businesses’ revenue compared to the same period in 2013.

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 and nine months ended September 30, 2014 as compared to the same periods in 2013:

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

*(In thousands)*

|  | For the three months ended September 30, 2014 | 2013 | For the nine months ended September 30, 2014 | 2013 |
| --- | ---: | ---: | ---: | ---: |
| Total O&M | $341,348 | $337,674 | $1,004,377 | $962,853 |
| Less: |  |  |  |  |
| O&M—Market-Based Operations | 77,401 | 59,682 | 204,460 | 172,684 |
| O&M—Other | (14,329) | (14,618) | (40,307) | (43,674) |
| Total Regulated O&M | 278,276 | 292,610 | 840,224 | 833,843 |
| Less: |  |  |  |  |
| Regulated purchased water expense | 33,674 | 33,956 | 93,332 | 84,759 |
| Allocation of internal O&M | 9,936 | 7,988 | 29,472 | 26,132 |
| Adjusted Regulated O&M (a) | $234,666 | $250,666 | $717,420 | $722,952 |
| Total Operating Revenues | $846,169 | $822,190 | $2,279,950 | $2,172,694 |
| Less: |  |  |  |  |
| Operating revenues—Market-Based Operations | 96,980 | 83,558 | 253,857 | 221,751 |
| Operating revenues—Other | (4,512) | (4,459) | (13,353) | (13,282) |
| Total Regulated operating revenues | 753,701 | 743,091 | 2,039,446 | 1,964,225 |
| Less: Regulated purchased water expense\* | 33,674 | 33,956 | 93,332 | 84,759 |
| Adjusted Regulated operating revenues (b) | $720,027 | $709,135 | $1,946,114 | $1,879,466 |
| Regulated O&M efficiency ratio (a)/(b) | 32.6% | 35.3% | 36.9% | 38.5% |

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

*Making Efficient Use of Capital.* We made capital investments of approximately $313.7 million and $701.6 million during the three months and nine months ended September 30, 2014, respectively. Of this total year-to-date investment, approximately $695.4 million was for Company-funded capital improvements with the remaining $6.2 million for the acquisition of regulated water and/or wastewater systems. For the full-year of 2014, we estimate our total capital plan to be $1.0 billion, most of which will be allocated to upgrading our infrastructure and systems and we estimate up to an additional $15 million for acquisitions and strategic investment purposes.

*Expanding Markets and Developing New Offerings.* During the nine months ended September 30, 2014, our Regulated Businesses completed the purchase of five regulated water systems, one regulated wastewater system and three regulated water and wastewater systems. These acquisitions added approximately 2,100 water customers and 1,600 wastewater customers to our regulated operations. Also, as previously announced, in January 2014, our Military Services Group within our Market-Based Operations segment was awarded a contract for ownership, operation and maintenance of the water and wastewater systems at Hill Air Force Base in Utah. In August 2014, our Military Services Group was awarded a contract for ownership, operation and maintenance of the water and wastewater systems at Picatinny Arsenal in New Jersey. Additionally, during the nine months ended September 30, 2014, our Homeowner Services Group (“HOS”) expanded its water and sewer line protection programs into Arkansas, Louisiana, Maine, Minnesota, New Hampshire, Oklahoma, Vermont and Wyoming.

#### Other Matters.

*West Virginia Freedom Industries Chemical Spill.* As noted in the Form 10-K for the year ended December 31, 2013, on January 9, 2014, a chemical storage tank owned by Freedom Industries, Inc. leaked 4-methylcyclohexane methanol, or MCHM, and PPH/DiPHH, 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 $0.5 million and $11.4 million for the three and nine months ended September 30, 2014, respectively.

See Part II, Item 1, “Legal Proceedings” in this report for information regarding litigation and an investigation by the Public Service Commission of West Virginia relating to the Freedom Industries chemical spill. The Company and WVAWC believe that WVAWC has responded appropriately to, and has no responsibility for, the Freedom Industries chemical 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.

*Labor Dispute Regarding National Benefits Agreement.* The Company’s Form 10-Q for the quarter ended June 30, 2014 describes a dispute between the Company and most of the labor unions representing employees in the Regulated Businesses (the “Unions”) regarding the Company’s national benefits agreement. On October 13, 2014, the Company and the Utility Workers Union of America AFL-CIO entered into a settlement agreement designed to resolve the dispute between the Company and the Unions. Among other things, the settlement agreement provides for a new 2014-2018 National Benefits Agreement that will be in effect generally until July 31, 2018. In addition, the Company agreed to make a $10 million lump-sum payment, to be distributed in accordance with procedures set forth in the settlement agreement among eligible employees represented by the Unions and affected by implementation of the Company’s last, best and final offer effective January 1, 2011. The majority of the distributions are expected to be used to reimburse employees for medical claims arising during the relevant period and will be funded by the Group Insurance Plan for American Water Works Company, Inc. and Its Designated Subsidiaries and Affiliates - Active Employees VEBA (the “VEBA Trust”), to which the Company previously has made contributions. Therefore, amounts funded out of the VEBA Trust will not have an impact on earnings. The Unions approved the settlement agreement on October 30, 2014 and the National Labor Relations Board (the “NLRB”) approved the settlement agreement on October 31, 2014. The NLRB advised the Company that it will dismiss its petition for enforcement filed in the United States Court of Appeals for the Seventh Circuit and close the case after the Company has substantially complied with its obligations under the settlement agreement to make the lump sum payment and to post a notice to employees agreeable to the Company and acceptable to the NLRB.

### Consolidated Results of Operations and Changes from Prior Periods

*(Dollars in thousands, except per share amounts)*

|  | Three Months Ended September 30, 2014 | 2013 | Favorable (Unfavorable) Change | Nine Months Ended September 30, 2014 | 2013 | Favorable (Unfavorable) Change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating revenues | $846,169 | $822,190 | $23,979 | $2,279,950 | $2,172,694 | $107,256 |
| Operating expenses |  |  |  |  |  |  |
| Operation and maintenance | 341,348 | 337,674 | (3,674) | 1,004,377 | 962,853 | (41,524) |
| Depreciation and amortization | 106,789 | 102,495 | (4,294) | 318,398 | 303,002 | (15,396) |
| General taxes | 60,807 | 58,087 | (2,720) | 178,276 | 175,789 | (2,487) |
| (Gain) loss on asset dispositions and purchases | (60) | 768 | 828 | (616) | 529 | 1,145 |
| Total operating expenses, net | 508,884 | 499,024 | 9,860 | 1,500,435 | 1,442,173 | 58,262 |
| Operating income | 337,285 | 323,166 | 14,119 | 779,515 | 730,521 | 48,994 |
| Other income (expenses) |  |  |  |  |  |  |
| Interest, net | (75,445) | (77,389) | 1,944 | (222,673) | (233,260) | 10,587 |
| Allowance for other funds used during construction | 2,805 | 2,800 | 5 | 7,064 | 9,895 | (2,831) |
| Allowance for borrowed funds used during construction | 1,570 | 1,679 | (109) | 4,324 | 5,102 | (778) |
| Amortization of debt expense | (1,669) | (1,524) | (145) | (4,971) | (4,729) | (242) |
| Other, net | (733) | (449) | (284) | (2,591) | (1,481) | (1,110) |
| Total other income (expenses) | (73,472) | (74,883) | 1,411 | (218,847) | (224,473) | 5,626 |
| Income from continuing operations before income taxes | 263,813 | 248,283 | 15,530 | 560,668 | 506,048 | 54,620 |
| Provision for income taxes | 107,205 | 98,374 | (8,831) | 224,773 | 196,325 | (28,448) |
| Income from continuing operations | 156,608 | 149,909 | 6,699 | 335,895 | 309,723 | 26,172 |
| Loss from discontinued operations, net of tax | (4,423) | 756 | (5,179) | (6,288) | (152) | (6,136) |
| Net income | $152,185 | $150,665 | $1,520 | $329,607 | $309,571 | $20,036 |
| Basic earnings per share: (a) |  |  |  |  |  |  |
| Income from continuing operations | $0.87 | $0.84 |  | $1.88 | $1.74 |  |
| Loss from discontinued operations, net of tax | $(0.02) | $0.00 |  | $(0.04) | $(0.00) |  |
| Basic earnings per share | $0.85 | $0.85 |  | $1.84 | $1.74 |  |
| Diluted earnings per share: (a) |  |  |  |  |  |  |
| Income from continuing operations | $0.87 | $0.84 |  | $1.87 | $1.73 |  |
| Loss from discontinued operations, net of tax | $(0.02) | $0.00 |  | $(0.03) | $(0.00) |  |
| Diluted earnings per share | $0.85 | $0.84 |  | $1.83 | $1.73 |  |
| Average common shares outstanding during the period: |  |  |  |  |  |  |
| Basic | 178,992 | 177,965 |  | 178,800 | 177,671 |  |
| Diluted | 179,948 | 179,154 |  | 179,723 | 178,906 |  |
| (a) Amounts may not sum due to rounding |  |  |  |  |  |  |

26

The following is a discussion of the consolidated results of operations for the three and nine months ended September 30, 2014 compared to the three and nine months ended September 30, 2013:

#### Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013

***Operating revenues.*** Consolidated operating revenues for the quarter increased $24.0 million, or 2.9%, compared to the same quarter last year. The increase is the result of higher revenues in our Regulated Businesses segment of $10.6 million, which is mainly attributable to rate increases, incremental revenues from surcharges, balancing accounts and acquisitions, partially offset by reduced consumption in 2014 compared to 2013, which we believe is the result of cooler and wetter weather conditions in 2014. Also, contributing to the higher revenues was a $13.4 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 Polk as well as contract growth in our HOS. For further information, see the respective “Operating Revenues” discussions within the “Segment Results.”

***Operation and maintenance.*** Consolidated O&M increased by $3.7 million, or 1.1%, compared to the same period in 2013. The increase is primarily due to higher O&M costs in our Market-Based Operations segment of $17.7 million, principally due to increased activity under our military contracts, corresponding with the increased revenue. This increase was largely offset by a $14.3 million decrease in O&M costs for our Regulated Businesses segment primarily due to lower production costs and lower employee-related costs. 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 $4.3 million, or 4.2%, principally as a result of additional utility plant placed in service, including our Customer Information and Enterprise Asset Management systems that went into service during the second and fourth quarters of 2013.

***General Taxes:*** General taxes increased $2.7 million or 4.7% due to higher property tax assessments in Pennsylvania and Kentucky.

***Other income (expenses).*** Other expenses decreased by $1.4 million, or 1.9%, 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.

***Provision for income taxes.*** Our consolidated provision for income taxes increased $8.8 million, or 9.0%, to $107.2 million for the three months ended September 30, 2014. The effective tax rates for the three months ended September 30, 2014 and 2013 were 40.6% and 39.6%, respectively. Included in the three months ended September 30, 2014 were $2.1 million of discrete tax items associated with uncertain tax positions.

***Loss from discontinued operations, net of tax.*** As noted above, the financial results of our Terratec line of business within our Market-Based segment has been classified as discontinued operations for all periods presented. The increase in loss from discontinued operations, net of tax is primarily related to costs associated with the pending sale and an income tax valuation allowance and lower operating result for the quarter.

#### Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013

***Operating revenues.*** Consolidated operating revenues increased $107.3 million, or 4.9%. The increase is the result of higher revenues in our Regulated Businesses segment of $75.2 million, mainly attributable to rate increases, incremental revenues from surcharges and balancing accounts, partially offset by reduced consumption in 2014, mainly due to the cooler and wetter weather in 2014 compared to 2013. Also contributing to the higher revenues was a $32.1 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, with the largest increases at Forts Polk and Leavenworth, and contract growth in our HOS. For further information, see the respective “Operating Revenues” discussions within the “Segment Results.”

***Operation and maintenance.*** Consolidated O&M increased by $41.5 million, or 4.3%. The increase is primarily due to higher O&M costs in our Regulated Businesses segment of $6.4 million, principally due to increased production costs, uncollectible expense, maintenance expense and costs associated with the Freedom Industries chemical spill in West Virginia, partially offset by lower employee-related costs. The increase in our Market-Based Operations segment of $31.8 million was mainly from incremental costs related to increased activity under our military contracts, corresponding with the increased revenue. For further discussions on the changes in our Regulated Businesses and Market-Based Operations segments’ O&M, see the respective “Operation and Maintenance” discussions within the “Segment Results.”

***Depreciation and amortization.*** Depreciation and amortization expense increased by $15.4 million, or 5.1%, principally as a result of additional utility plant placed in service, including our Customer Information and Enterprise Asset Management systems that were placed into service during the second and fourth quarters of 2013.

***Other income (expenses).*** Other expenses decreased by $5.6 million, or 2.5% . 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 our Customer Information and Enterprise Asset Management systems being placed into service in the second and fourth quarters of 2013.

***Provision for income taxes.*** Our consolidated provision for income taxes increased $28.4 million, or 14.5%. The effective tax rates for the nine months ended September 30, 2014 and 2013 were 40.1% and 38.8%, respectively. Included in the nine months ended September 30, 2014 were $2.0 million of discrete tax items associated with uncertain tax positions. The 2013 rate included a $3.3 million tax benefit associated with a legal structure reorganization in our Market-Based Operations segment. This strategic restructuring allowed us to utilize state net operating loss carryforwards prior to their expiration.

***Loss from discontinued operations, net of tax.*** As noted above, the financial results of our Terratec line of business within our Market-Based segment has been classified as discontinued operations for all periods presented. The increase in loss from discontinued operations, net of tax is primarily related to costs associated with the pending sale and an income tax valuation allowance and lower operating results.

### 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 September 30, 2014 | 2013 | Increase (Decrease) | For the nine months ended September 30, 2014 | 2013 | Increase (Decrease) |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating revenues | $753,701 | $743,091 | $10,610 | $2,039,446 | $1,964,225 | $75,221 |
| Operation and maintenance expense | 278,276 | 292,610 | (14,334) | 840,224 | 833,843 | 6,381 |
| Operating expenses, net | 434,912 | 442,231 | (7,319) | 1,302,298 | 1,277,264 | 25,034 |
| Income from continuing operations before income taxes | 258,539 | 240,977 | 17,562 | 555,985 | 509,765 | 46,220 |

***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 generally is 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 $10.6 million, or 1.4%, for the quarter ended September 30, 2014, as compared to the same period in 2013. The increase in revenues is principally due to incremental revenues of approximately $23.0 million of rate increases resulting from rate authorizations for a number of our operating companies. Additionally, revenue increased by $1.8 million due to increased surcharges and balancing accounts and approximately $3.7 million of incremental revenues attributable to acquisitions. The most significant contributor to the increase in revenues from acquisitions was Dale Service Corporation (“Dale”), which was acquired by our Virginia subsidiary in the fourth quarter of 2013. Partially offsetting these increases was a decrease in revenues of approximately $18.7 million as a result of lower demand, of which a large portion is believed to be the result of cooler and wetter weather this year compared to last year.

Operating revenues increased by $75.2 million, or 3.8%, for the nine months ended September 30, 2014, as compared to the same period in 2013. The increase in revenues is principally due to incremental revenues of approximately $63.7 million attributable to rate increases from rate authorizations for a number of our operating companies partially offset by a reduction in consumption levels of approximately $11.5 million. As previously mentioned, we believe a large portion of this consumption decrease is the result of cooler and wetter weather this year compared to last year. Additionally, revenue increased by $10.2 million due to increased surcharges and balancing accounts and approximately $10.5 million as a result of 2013 acquisitions. The most significant contributor to the increase in revenues from acquisitions was Dale.

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

| Customer Class Water service | For the three months ended September 30, 2014 2013 Increase (Decrease) Percentage Operating Revenues (dollars in thousands) | 2014 2013 Increase (Decrease) Percentage Billed Water Sales Volume (gallons in millions) |
| --- | ---: | ---: |
| Residential | $431,906 $420,307 $11,599 2.8% | 53,523 55,905 (2,382) (4.3%) |
| Commercial | 155,761 152,640 3,121 2.0% | 23,758 24,789 (1,031) (4.2%) |
| Industrial | 35,349 33,026 2,323 7.0% | 10,405 10,081 324 3.2% |
| Public and other | 87,868 87,510 358 0.4% | 15,045 15,531 (486) (3.1%) |
| Other water revenues | 12,458 7,201 5,257 73.0% | — — — — |
| Billed water services | 723,342 700,684 22,658 3.2% | 102,731 106,306 (3,575) (3.4%) |
| Unbilled water services | (6,012) 9,384 (15,396) (164.1%) |  |
| Total water service revenues | 717,330 710,068 7,262 1.0% |  |
| Wastewater service revenues | 23,059 20,720 2,339 11.3% |  |
| Other revenues | 13,312 12,303 1,009 8.2% |  |
|  | $753,701 $743,091 $10,610 1.4% |  |
|  | **For the nine months ended September 30,** |  |
|  | **2014** **2013** **Increase (Decrease)** **Percentage** | **2014** **2013** **Increase (Decrease)** **Percentage** |
|  | **Operating Revenues (dollars in thousands)** | **Billed Water Sales Volume (gallons in millions)** |
| **Customer Class** |  |  |
| Water service |  |  |
| Residential | $1,150,336 $1,100,767 $49,569 4.5% | 135,165 136,356 (1,191) (0.9%) |
| Commercial | 416,197 395,622 20,575 5.2% | 61,839 61,129 710 1.2% |
| Industrial | 100,337 90,044 10,293 11.4% | 29,811 27,235 2,576 9.5% |
| Public and other | 253,127 238,701 14,426 6.0% | 40,964 39,821 1,143 2.9% |
| Other water revenues | 21,057 16,187 4,870 30.1% | — — — — |
| Billed water services | 1,941,054 1,841,321 99,733 5.4% | 267,779 264,541 3,238 1.2% |
| Unbilled water services | (8,973) 27,469 (36,442) (132.7%) |  |
| Total water service revenues | 1,932,081 1,868,790 63,291 3.4% |  |
| Wastewater service revenues | 69,721 60,955 8,766 14.4% |  |
| Other revenues | 37,644 34,480 3,164 9.2% |  |
|  | $2,039,446 $1,964,225 $75,221 3.8% |  |

*Water Services –* Water service operating revenues for the three months ended September 30, 2014 totaled $717.3 million, a $7.3 million increase, or 1.0%, over the same period of 2013. For the nine months ended September 30, 2014, these revenues increased $63.3 million, or 3.4%, compared to the nine months ended September 30, 2013. As described above, the increases for both the three and nine months ended September 30, 2014 are primarily due to rate increases, incremental revenues associated with surcharges and amortization of balancing accounts and recent acquisitions. Also, it should be noted that the mix between billed revenues and unbilled revenues for the three and nine months ended September 30, 2014, as compared to the same periods 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 addressed a majority of these delayed billings. Therefore, as a result, the change in unbilled water revenue for the three and nine-month periods ended September 30, 2014, compared to the same periods in 2013, decreased by $15.4 million and $36.4 million, respectively, with corresponding increases in billed revenues.

*Wastewater services –* Our subsidiaries provide wastewater services in eleven states. Revenues from these services increased $2.3 million, or 11.3%, and $8.8 million, or 14.4%, for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The increase is primarily attributable to the Dale acquisition in the fourth quarter of 2013.

*Other revenues –* Other revenues, which include such items as reconnection charges, initial application service fees, certain rental revenues, revenue collection services for others and similar items, increased $1.0 million, or 8.2%, and $3.2 million, or 9.2%, for the three and nine months ended September 30, 2014, respectively. The increase for the three months ended September 30, 2014 is principally due to the additional surcharge revenues. The nine-month period increase is primarily due to $2.4 million in insurance proceeds for business interruption as a result of Hurricane Sandy in addition to an increase in late payment fees.

***Operation and maintenance expense.*** Operation and maintenance expense decreased $14.3 million, or 4.9%, and increased $6.4 million, or 0.8%, for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013.

The following table provides information regarding operation and maintenance expense for the three and nine months ended September 30, 2014 and 2013, by major expense category:

*(Dollars in thousands)*

|  | For the three months ended September 30, 2014 | 2013 | Increase (Decrease) | Percentage | For the nine months ended September 30, 2014 | 2013 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Production costs | $79,455 | $82,093 | $(2,638) | (3.2%) | $222,855 | $207,698 | $15,157 | 7.3% |
| Employee-related costs | 106,672 | 114,127 | (7,455) | (6.5%) | 321,452 | 342,611 | (21,159) | (6.2%) |
| Operating supplies and services | 53,204 | 54,215 | (1,011) | (1.9%) | 163,460 | 163,998 | (538) | (0.3%) |
| Maintenance materials and supplies | 15,421 | 15,357 | 64 | 0.4% | 53,581 | 47,733 | 5,848 | 12.3% |
| Customer billing and accounting | 15,420 | 16,193 | (773) | (4.8%) | 44,707 | 38,380 | 6,327 | 16.5% |
| Other | 8,104 | 10,625 | (2,521) | (23.7%) | 34,169 | 33,423 | 746 | 2.2% |
| Total | $278,276 | $292,610 | $(14,334) | (4.9%) | $840,224 | $833,843 | $6,381 | 0.8% |

Production costs by major expense type were as follows:

*(Dollars in thousands)*

|  | For the three months ended September 30, 2014 | 2013 | Increase (Decrease) | Percentage | For the nine months ended September 30, 2014 | 2013 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Purchased Water | $33,674 | $33,956 | $(282) | (0.8%) | $93,332 | $84,759 | $8,573 | 10.1% |
| Fuel and Power | 25,890 | 25,990 | (100) | (0.4%) | 71,025 | 66,227 | 4,798 | 7.2% |
| Chemicals | 12,521 | 15,063 | (2,542) | (16.9%) | 35,316 | 36,997 | (1,681) | (4.5%) |
| Waste Disposal | 7,370 | 7,084 | 286 | 4.0% | 23,182 | 19,715 | 3,467 | 17.6% |
| Total | $79,455 | $82,093 | $(2,638) | (3.2%) | $222,855 | $207,698 | $15,157 | 7.3% |

Production costs decreased by $2.6 million, or 3.2%, for the three months ended September 30, 2014 and increased by $15.1 million, or 7.3%, for the nine months ended September 30, 2014. The decrease for the three month period was primarily due to a $1.8 million reversal of chemical expense resulting from a favorable litigation settlement. The increase for the nine month period was primarily due to increases in purchased water, fuel and power costs and waste disposal. Partially offsetting these increases was a decrease in chemicals due to the credit discussed above. The purchased water increases principally reflect increased prices in our California subsidiary. Fuel and power costs increased due to increased customer demand and higher supplier prices in several of our operating facilities as well as incremental costs as a result of the Dale acquisition in the fourth quarter of 2013. The increase in waste disposal costs for both the three and nine month periods was principally due to an increase in the amount allowed by a cost recovery mechanism in one of our operating companies and the Dale acquisition. Also contributing to the nine month increase was incremental costs associated with the Freedom Industries chemical spill in West Virginia.

The following table provides information with respect to components of employee-related costs for the three and nine months ended September 30, 2014 and 2013:

*(Dollars in thousands)*

|  | For the three months ended September 30, 2014 | 2013 | Increase (Decrease) | Percentage | For the nine months ended September 30, 2014 | 2013 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Salaries and wages | $81,456 | $81,211 | $245 | 0.3% | $245,107 | $241,617 | $3,490 | 1.4% |
| Pensions | 6,648 | 11,976 | (5,328) | (44.5%) | 20,268 | 36,604 | (16,336) | (44.6%) |
| Group insurance | 13,759 | 16,636 | (2,877) | (17.3%) | 41,889 | 50,283 | (8,394) | (16.7%) |
| Other benefits | 4,809 | 4,304 | 505 | 11.7% | 14,188 | 14,107 | 81 | 0.6% |
| Total | $106,672 | $114,127 | $(7,455) | (6.5%) | $321,452 | $342,611 | $(21,159) | (6.2%) |

30

The overall decrease in employee-related costs for the three and nine months ended September 30, 2014, compared to the same periods in 2013, was primarily due to a reduction in pension costs and postretirement benefit costs (which is included in group insurance expenses). These decreases are principally due to the change in assumptions used for the discount rate, which in turn resulted in decreased contributions. The decrease in contributions occurred principally at those 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 and nine months ended September 30, 2014, compared to the same periods in 2013. For the three month period, the increase is the result of annual wage and overtime expense increases offset by higher capitalization rates as a result of increased capital projects. For the nine month period, the increase is the result of annual wage increases and increased overtime expense attributable to an increased number of main breaks as a result of the harsh winter weather conditions, offset by a reduction in incentive compensation due to a lower than expected payout for the 2013 incentive period as well as higher capitalization rates as a result of increased capital projects.

Maintenance materials and supplies, which include preventive maintenance and emergency repair costs, remained relatively unchanged for the three months ended September 30, 2014 compared to the same period in 2013. The increase of $5.8 million, or 12.3%, for the nine months ended September 30, 2014, compared to the same period in 2013, is primarily due to an increase in tank painting costs in one of our subsidiaries and increases in paving, backfilling and other repair costs, most of which are from the higher than normal main breaks in the first quarter of 2014 due to the abnormally harsh winter weather conditions experienced throughout our operating areas.

Customer billing and accounting expenses, which include uncollectible accounts expense, postage and other customer related expenses, decreased by $0.8 million, or 4.8%, for the three months ended September 30, 2014 and increased by $6.3 million, or 16.5%, for the nine months ended September 30, 2014. The increase for the nine-month period is primarily due to incremental uncollectible expense associated with an increase in customer accounts receivable attributable to the overall 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. As such we anticipate uncollectible expense will continue to be higher this year.

Other operation and maintenance expense includes casualty and liability insurance premiums and regulatory costs. The decrease in these costs for the three months ended September 30, 2014 compared to the prior year period was primarily driven by lower regulatory expenses as well as lower casualty insurance costs, as a result of historical claims experience, and retroactive premium adjustments. The increase for the nine-month period ended September 30, 2014 compared to the nine months ended September 30, 2013 was primarily due to an increase in our expected retroactive premiums, principally due to incremental claims associated with the Freedom Industries chemical spill in West Virginia, net of favorable forecasted experience for already existing claims. These retroactive premiums are based upon current facts and circumstances with respect to outstanding claims and are subject to change as the claims mature. The increase in insurance costs is partially offset by lower regulatory expenses in one of our operating subsidiaries compared to the same period in the prior year.

***Operating expenses.*** The decrease in operating expenses, for the three and nine months ended September 30, 2014, is principally due to the decreases in operation and maintenance expense explained above and higher depreciation and amortization expense of $4.5 million and $16.1 million for the three and nine months ended September 30, 2014, respectively. The increase in depreciation and amortization is primarily due to additional utility plant placed in service, including CIS and our Enterprise Asset Management system.

### Market-Based Operations

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

*(In thousands)*

|  | For the three months ended September 30, 2014 | 2013 | Increase (Decrease) | For the nine months ended September 30, 2014 | 2013 | Increase (Decrease) |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating revenues | $96,980 | $83,558 | $13,422 | $253,857 | $221,751 | $32,106 |
| Operation and maintenance expense | 77,401 | 59,682 | 17,719 | 204,460 | 172,684 | 31,776 |
| Operating expenses, net | 79,915 | 62,957 | 16,958 | 212,075 | 181,526 | 30,549 |
| Income from continuing operations before income taxes | 17,634 | 21,457 | (3,823) | 43,593 | 42,570 | 1,023 |

***Operating revenues.*** Revenues for the three and nine months ended September 30, 2014 increased $13.4 million and $32.1 million, respectively, compared to the same periods in 2013, as a result of incremental revenues in our Contract Operations Group (“ConOp”) and HOS lines of business. For the three and nine months ended September 30, 2014, our ConOp revenue increased $9.9 million and $19.8 million, respectively. These increases are primarily related to additional revenues from capital project activities associated with our military contracts. Partially offsetting these incremental revenues were the effects of retroactive price redeterminations for several of our military contracts which increased revenues by $3.4 million and $5.7 million for the three and nine months ended September 30, 2013, respectively. Other decreases in revenues in the 2014 periods compared to the prior year periods include terminated municipal and industrial operations and maintenance contracts. HOS revenues increased $3.5 million and $12.6 million for the three and nine months ended September 30, 2014, respectively. These increases were principally the result of contract growth, mainly through our New York City contracts, as well as expansion into other geographic areas and price increases for certain existing customers.

***Operation and maintenance.*** Operation and maintenance expense increased $17.7 million, or 29.7%, and $31.8 million, or 18.4% for the three and nine months ended September 30, 2014, respectively.

The following table provides information regarding categories of operation and maintenance expense for the periods indicated:

*(Dollars in thousands)*

|  | For the three months ended September 30, 2014 | 2013 | Increase (Decrease) | Percentage | For the nine months ended September 30, 2014 | 2013 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Production costs | $8,511 | $9,333 | $(822) | (8.8%) | $26,372 | $27,803 | $(1,431) | (5.1%) |
| Employee-related costs | 15,993 | 14,673 | 1,320 | 9.0% | 45,069 | 44,162 | 907 | 2.1% |
| Operating supplies and services | 38,836 | 24,757 | 14,079 | 56.9% | 93,518 | 67,611 | 25,907 | 38.3% |
| Maintenance materials and supplies | 12,443 | 9,778 | 2,665 | 27.3% | 34,753 | 30,161 | 4,592 | 15.2% |
| Other | 1,618 | 1,141 | 477 | 41.8% | 4,748 | 2,947 | 1,801 | 61.1% |
| Total | $77,401 | $59,682 | $17,719 | 29.7% | $204,460 | $172,684 | $31,776 | 18.4% |

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 mainly attributable to the increase in construction project activities under our military contracts and corresponds with the incremental revenues. Additionally, included in the three and nine months ended September 30, 2013 was the release of $3.8 million in loss contract reserves due to the resolution of certain outstanding issues and uncertainties. The increase in maintenance materials and supplies increased primarily due to higher HOS repair costs, which is attributable to new contracts.

***Operating expense.*** The changes in operating expenses for the three and nine months ended September 30, 2014, compared to the same periods 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 September 30, 2014, AWCC had no outstanding borrowings and $39.7 million of outstanding letters of credit under the revolving credit facility. As of September 30, 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 $314.0 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 continuing operating activities for the nine months ended September 30, 2014 were $840.9 million compared to $688.5 million for the nine months ended September 30, 2013.

The following table provides a summary of the major items affecting our cash flows from continuing operating activities for the nine months ended September 30, 2014 and 2013:

*(In thousands)*

|  | Nine Months Ended September 30, 2014 | 2013 |
| --- | ---: | ---: |
| Net income | $329,607 | $309,571 |
| Add (subtract): |  |  |
| Non-cash activities (1) | 576,381 | 561,285 |
| Changes in working capital (2) | (29,303) | (104,643) |
| Pension and postretirement healthcare contributions | (35,783) | (77,664) |
| Net cash flows provided by continuing operations | $840,902 | $688,549 |

(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 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.

The increase in cash flows from operating activities during the nine months ended September 30, 2014 as compared to the same period in 2013 reflects higher net income adjusted for non-cash activities, changes in working capital and a reduction in pension and postretirement benefit contributions. The increase in working capital for the nine months ended September 30, 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.

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 segment. 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, has showed improvement during 2014 compared to the second half of 2013. In the second half of 2013, the rate of cash collections, particularly 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 a result of certain process decisions, made as part of the CIS implementation, including the manual validation of bills prior to mailing to customers and decreased collection efforts. Therefore, we believe this situation to be only temporary in nature. Although cash collections increased during the first nine months of 2014, there are no assurances that the rate of cash collections will continue or be consistent with previous historical collection patterns.

### Cash Flows from Investing Activities

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

*(In thousands)*

|  | Nine Months Ended September 30, 2014 | 2013 |
| --- | ---: | ---: |
| Net capital expenditures | $(664,859) | $(664,975) |
| Proceeds from sale of assets and securities | 804 | 749 |
| Acquisitions | (6,053) | (16,554) |
| Other investing activities, net (1) | (51,221) | (38,300) |
| Net cash flows used in investing activities of continuing operations | $(721,329) | $(719,080) |

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

### 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 (net of refunds) and contributions in aid of 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 proceeds of those borrowings to the regulated subsidiaries and the parent company. The regulated subsidiaries and the parent company are obligated to pay to AWCC their respective portion of principal and interest in the amount required 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.

We intend to utilize commercial paper for short-term liquidity, as commercial paper borrowings have historically been a more flexible and lower cost option. However, if necessary, we utilize our credit facility to complement our borrowings in the commercial paper market. In the event of disruptions in the money market sector of the debt capital markets, borrowings under our revolving credit facility may be more efficient and a lower cost alternative to commercial paper.

The following table provides information on long-term debt that was issued during the first nine months of 2014:

| Company | Type | Rate | Maturity | Amount (In thousands) |
| --- | --- | --- | --- | ---: |
| American Water Capital Corp. (1) | Senior notes—fixed rate | 3.40%-4.30% | 2025-2042 | $500,000 |
| Other subsidiaries (2) | Private activity bonds and government funded debt—fixed rate | 0.00%-5.00% | 2031-2033 | 10,474 |
| Total issuances |  |  |  | $510,474 |

(1) On August 14, 2014, AWCC closed on senior fixed rate notes. Proceeds used to refinance commercial paper borrowings and to finance redemptions of long-term debt.

(2) Proceeds from the above issuance, which were initially kept in trust, were received from New Jersey Environmental Infrastructure Trust and will be used to fund certain specific projects. The proceeds are held in trust pending our certification that we have incurred qualifying expenditures. These issuances have been presented as non-cash in the accompanying Consolidated Statements of Cash Flows. Subsequent releases of the funds will be reflected as net funds released in the cash flows from investing activities section of the Consolidated Statements of Cash Flows.

In addition to the above issuance, we also assumed $1.7 million of debt as a result of an acquisition.

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

| Company | Type | Rate | Maturity | Amount (In thousands) |
| --- | --- | ---: | --- | ---: |
| American Water Capital Corp. | Private activity bonds and government funded debt—fixed rate | 6.00%-6.75% | 2014-2031 | $77,760 |
| American Water Capital Corp. | Senior notes—fixed rate | 6.00% | 2039 | 9 |
| Other subsidiaries (1) | Private activity bonds and government funded debt—fixed rate | 0.00%-5.25% | 2014-2041 | 60,165 |
| Other subsidiaries | Mandatorily redeemable preferred stock | 8.49% | 2036 | 1,200 |
| Other subsidiaries | Capital lease payments |  |  | 20 |
| Total retirements and redemptions |  |  |  | $139,154 |

(1) Includes $1.2 million of non-cash defeasance via the use of restricted funds.

In September 2014, AWCC issued a notice of redemption for $23.3 million of outstanding 6.25% Senior Notes with an original maturity of 2032. These notes will be retired on November 1, 2014. Also, in September, our New York subsidiary issued a notice of redemption for 4.9% notes with an original maturity of 2034. These notes were retired on October 1, 2014. Lastly, on October 9, 2014, we issued a notice of redemption for $59.6 million of outstanding 6.00% Senior Notes with an original maturity date of 2039. These notes will be retired on December 1, 2014.

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 transactions.

### Credit Facilities and Short-Term Debt

Short-term debt balance, consisting of commercial paper, net of discount, amounted to $314.0 million at September 30, 2014.

The following table provides information as of September 30, 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 |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| September 30, 2014 | $1,250,000 | $1,210,337 | $150,000 | $110,337 | $313,979 | $— |

The weighted-average interest rate on short-term borrowings for the three months ended September 30, 2014 and 2013 was approximately 0.29% and 0.33%, respectively, and 0.29% and 0.36% for the nine months ended September 30, 2014 and 2013, respectively.

### Capital Structure

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

|  | At September 30, 2014 | At December 31, 2013 |
| --- | ---: | ---: |
| Total common stockholders' equity | 45% | 45% |
| Long-term debt and redeemable preferred stock at redemption value | 51% | 49% |
| Short-term debt and current portion of long-term debt | 4% | 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. For two of our smaller operating companies, we have informed our counterparties that we will provide only unaudited financial information at the subsidiary level, which resulted in technical non-compliance with certain of their reporting requirements. We do not believe this change will materially impact us. 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 (as defined in the relevant documents) of not more than 0.70 to 1.00. As of September 30, 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 September 30, 2014:

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

35

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 if a 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 our debt is 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 reference 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. On June 2, 2014 and September 2, 2014, we made quarterly cash dividend payments of $0.31 per share to all shareholders of record as of May 12, 2014 and August 11, 2014, respectively.

To permit our shareholders to take advantage of 2012 tax rates, the cash dividend payment that would have historically been paid in March 2013 was paid in December 2012. On June 3, 2013 and September 3, 2013, we made cash dividend payments of $0.28 per share to all shareholders of record as of May 24, 2013 and August 19, 2013, respectively.

On September 19, 2014 our board of directors declared a quarterly cash dividend payment of $0.31 per share payable on December 1, 2014 to all shareholders of record as of November 10, 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 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 for a discussion of our critical accounting policies.

### Recent Accounting Pronouncements

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

## Market risk

As filed, 283 characters.

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

## Controls and procedures

As filed, 2,005 characters.

### Evaluation of Disclosure Controls and Procedures

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

Our management, including the Chief Executive Officer and the Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) of the Exchange Act) as of September 30, 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 September 30, 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 September 30, 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 Nov 5, 2014.
Source: SEC EDGAR, the filing index for accession 0001564590-14-005041. Last ingested by Listed: Nov 6, 2026, 17:16 ET. No prices; not investment advice.