# American Water Works Company, Inc.: Form 10-Q for the period ended Sep 30, 2015

- Company: [American Water Works Company, Inc.](/companies/awk.md) (CIK 1410636)
- Form: 10-Q
- Filed: 2015-11-04
- Accepted by EDGAR: Nov 4, 2015, 17:22 ET
- Period: 2015-09-30
- Accession: 0001564590-15-009409
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1410636/000156459015009409/awk-10q_20150930.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1410636/000156459015009409/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2015-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Operating income | 3 months, 2015-07-01 to 2015-09-30 | $361.3m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2015-01-01 to 2015-09-30 | $843.1m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2015-07-01 to 2015-09-30 | $77.6m | us-gaap:InterestExpense |
| Interest expense | 9 months, 2015-01-01 to 2015-09-30 | $228.7m | us-gaap:InterestExpense |
| Income tax | 3 months, 2015-07-01 to 2015-09-30 | $113.2m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2015-01-01 to 2015-09-30 | $247.2m | us-gaap:IncomeTaxExpenseBenefit |
| Diluted EPS | 3 months, 2015-07-01 to 2015-09-30 | $0.96 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2015-01-01 to 2015-09-30 | $2.09 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2015-07-01 to 2015-09-30 | $0.97 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2015-01-01 to 2015-09-30 | $2.10 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2015-07-01 to 2015-09-30 | 180,353,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2015-01-01 to 2015-09-30 | 180,346,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2015-01-01 to 2015-09-30 | $855.6m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Dividends paid | 9 months, 2015-01-01 to 2015-09-30 | $177.7m | us-gaap:PaymentsOfDividendsCommonStock |
| Share repurchases | 9 months, 2015-01-01 to 2015-09-30 | $39.3m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2015-09-30 | $75.2m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2015-09-30 | $879.0m | us-gaap:AssetsCurrent |
| Total assets | at 2015-09-30 | $17.11bn | us-gaap:Assets |
| Current liabilities | at 2015-09-30 | $1.17bn | us-gaap:LiabilitiesCurrent |
| Long-term debt | at 2015-09-30 | $5.96bn | us-gaap:LongTermDebt |
| Short-term borrowings | at 2015-09-30 | $379.9m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2015-09-30 | $5.17bn | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 66,158 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 (the “Exchange Act”). 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, 2014, and in this Form 10-Q, each as 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. (“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. These utilities are generally subject to economic regulation by state regulatory agencies in the states in which they operate. We report the financial results of these utilities in our Regulated Businesses segment. We also provide other services through businesses that are not subject to economic regulation by state regulatory agencies. We report the results of these businesses in our Market-Based Businesses segment. For further description of our businesses see Part I, Item 1, “Business,” in our Form 10-K and “Overview - Growth - Infrastructure improvements, acquisitions and strategic investments” in this section.

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

### Overview

### Financial Results

Highlights of our operating results per diluted share for the three and nine months ended September 30, 2015 compared to same periods during 2014 are as follows:

|  | Three Months Ended September 30, 2015 | 2014 | Nine Months Ended September 30, 2015 | 2014 |
| --- | ---: | ---: | ---: | ---: |
| Income from continuing operations | $0.96 | $0.87 | $2.09 | $1.87 |
| Loss from discontinued operations, net of tax | $0.00 | $(0.02) | $0.00 | $(0.03) |
| Diluted earnings per share | $0.96 | $0.85 | $2.09 | $1.83 |

### Continuing Operations

Income from continuing operations increased 9 cents and 22 cents per diluted share for the three and nine months ended September 30, 2015, respectively, compared to the same periods in the prior year. Excluding the costs related to the Freedom Industries chemical spill in West Virginia of 4 cents per diluted share for the nine months ended September 30, 2014, income for the nine months ended September 30, 2015 increased 18 cents per diluted share. The increases for both the three and nine month periods in 2015 compared to 2014 was mainly due to continued growth in both our Regulated Businesses and Market-Based Businesses segments.

For the quarter ended September 30, 2015, our Regulated Businesses segment continued to experience growth through infrastructure investment along with an increase in demand compared to the same period in the prior year. Our Market-Based Businesses segment also continued to experience earnings growth through its Military Services Group (“MSG”) line of business.

For the nine months ended September 30, 2015, the Regulated Businesses segment experienced growth through infrastructure investments and increased demand coupled with lower operating and maintenance expenses from a continued focus on operational efficiency. Our Market-Based Businesses segment also continued to experience earnings growth through its MSG line of business.

### Discontinued Operations

In the fourth quarter of 2014, we sold our Terratec line of business, which was part of our Market-Based Businesses segment. The after-tax loss from discontinued operations for both the three and nine months ended September 30, 2014 includes the operating results of the entity prior to the sale.

### Regulatory Matters

The table below provides rate authorizations by state of annualized revenues awarded assuming a constant volume and effective in 2015:

*(In millions)*

| State General Rate Cases: | For the Three Months Ended September 30, 2015 | For the Nine Months Ended September 30, 2015 |
| --- | ---: | ---: |
| New Jersey (September 21) | $22.0 | $22.0 |
| Kentucky (July 2) (a) | — | — |
| Maryland (June 19) | — | 0.5 |
| Indiana (January 29) | — | 5.1 |
| California (January 1) | — | 5.2 |
| Total General Rate cases | $22.0 | $32.8 |
| Infrastructure charges: |  |  |
| Pennsylvania (b) | $4.6 | $6.2 |
| New Jersey (January 1) | — | 9.4 |
| Illinois (c) | — | 5.9 |
| Tennessee (June 30) | — | 2.2 |
| Missouri (June 27) (d) | — | 1.9 |
| New York (June 1) | — | 0.1 |
| Total Infrastructure charges | $4.6 | $25.7 |

(a) Additional annualized revenue granted of $0.2 million; increase is effective in one-fourth increments over each of the next four years.

(b) Rates of $1.6 million and $4.6 million became effective April 1, 2015 and July 1, 2015, respectively.

(c) Rates of $4.9 million and $1.0 million became effective January 1, 2015 and February 1, 2015, respectively.

(d) The Office of the Public Counsel filed an appeal notice claiming St. Louis County no longer meets the required population requirement for an infrastructure charge.

In July 2015, our California subsidiary filed an application with the California Public Utilities Commission (the “CPUC”) to request changes to the present rate design and the emergency conservation and rationing plan for water customers in certain areas within its Monterey County service district. If approved, the proposed changes would allow (i) recovery of existing under-collections of the net water revenue adjustment mechanism/modified cost balancing account (“WRAM/MCBA”) balance, currently amounting to approximately $43 million, over 20 years earning a pretax rate of 8.41%; (ii) an annual consumption true-up mechanism and rate design that provide for more timely collection of the cost of service; and (iii) modification of existing conservation and rationing plans. We expect a CPUC decision in mid to late 2016. On November 4, 2015, our California subsidiary received an Assigned Commissioner’s Scoping Memo and Ruling related to our WRAM filing. The Company is reviewing the terms of this document to determine the impact on the WRAM filing and the related timing of the decision, if any.

On July 31, 2015, our Missouri subsidiary filed a general rate case requesting additional annualized revenue of approximately $25.2 million.

Following the close of the third quarter, additional annualized revenue of $7.8 million resulting from infrastructure charges in our Pennsylvania subsidiary became effective on October 1, 2015. Also, on October 30, 2015, our Virginia subsidiary filed a general rate case requesting additional annualized revenue of approximately $8.7 million.

As of November 4, 2015, we are awaiting final general rate case orders in three states, requesting additional annualized revenue of $69.5 million. There is no assurance that all or any portion of these requests will be granted.

### Focusing on Central Themes

For 2015, our focus is anchored on five central themes: 1) Customers, 2) Safety, 3) People, 4) Growth and 5) Operational Efficiency. We will continue our focus on operating our business responsibly and managing our operating and capital costs in a manner that benefits our customers and produces value for our shareholders. Additionally, we will continue our ongoing strategy that ensures a safe workplace for our employees, emphasizes public safety for our customers and communities, and leverages our human resources, processes and technology innovation to make our business more effective and efficient. The progress that we have made in the first nine months of 2015 with respect to growth and improvement in our operational efficiency ratio is described below.

### Growth - Infrastructure improvements, acquisitions and strategic investments

During the nine months of 2015, we made capital investments of approximately $969.9 million, focused in three key areas:

- $793.1 million to improve infrastructure in our Regulated Businesses.
- $132.8 million for the acquisition (the “Keystone Acquisition”) of our ninety-five percent interest in Water Solutions Holdings, LLC, the parent company of Keystone Clearwater Solutions, LLC (“Keystone”), in the third quarter of 2015. Keystone is a water service provider that offers a range of water-related services to the oil and gas industry in the Appalachian region and is included in our Market-Based Businesses segment.
- $44.0 million for regulated acquisitions, which added a total of more than 19,000 water and wastewater customers.

For the full-year of 2015, our total capital investment, including acquisitions, is expected to be in the range of $1.3 to $1.4 billion, most of which is for improving infrastructure in our Regulated Businesses.

### Technology and Operational Efficiency - Continuing Improvement in O&M Efficiency Ratio for our Regulated Businesses

We continued to improve on our operation and maintenance (“O&M”) efficiency ratio (a non-GAAP measure). Our adjusted O&M efficiency ratio for the twelve months ended September 30, 2015 was 35.8%, compared to 36.8% for the twelve months ended September 30, 2014. The improvement in the 2015 O&M efficiency ratio over this period was attributable to both an increase in revenue and decreases in O&M expenses.

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.

Our O&M efficiency ratio is defined as our regulated operation and maintenance expense divided by regulated operating revenues, where both O&M expense and operating revenues were adjusted to eliminate purchased water expense. Additionally, from the O&M expenses, we excluded the allocable portion of non-O&M support services cost, 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 accompanying Consolidated Statement of Operations and Comprehensive Income. In addition, to the standard adjustments to the O&M Efficiency ratio for the twelve months ended September 30, 2015 and 2014, we have also excluded from operating revenues and O&M expenses the estimated impact from changes in consumption as a result of weather and the West Virginia Freedom Industries chemical spill. We excluded all the above items from the calculation as we believe such items are not reflective of management’s ability to increase efficiency of the Company’s regulated operations.

The following table provides the calculation and reconciliation that compares O&M and operating revenues, as determined in accordance with GAAP, to those amounts utilized in the calculation of our adjusted O&M efficiency ratio for the twelve months ended September 30, 2015 as compared to the same period in 2014.

Calculation and Reconciliation of Adjusted Regulated O&M Efficiency Ratio (a Non-GAAP Measure):

*(In thousands)*

|  | For the Twelve Months Ended September 30, 2015 | 2014 |
| --- | ---: | ---: |
| Total Operation and Maintenance Expense | $1,369,553 | $1,330,605 |
| Less: |  |  |
| Operation and maintenance expense—Market-Based Businesses | 337,415 | 272,386 |
| Operation and maintenance expense—Other | (52,805) | (53,606) |
| Total Regulated Operation and Maintenance Expense | 1,084,943 | 1,111,825 |
| Less: |  |  |
| Regulated purchased water expense | 117,801 | 119,692 |
| Allocation of non-operation and maintenance expense | 37,095 | 37,975 |
| Impact of West Virginia Freedom Industries chemical spill | 136 | 10,302 |
| Estimated impact of weather (mid-point of range) | — | (1,762) |
| Adjusted Regulated Operation and Maintenance Expense (a) | $929,911 | $945,618 |
| Total Operating Revenues | $3,107,783 | $2,986,192 |
| Less: |  |  |
| Operating revenues—Market-Based Businesses | 408,643 | 334,647 |
| Operating revenues—Other | (18,693) | (17,594) |
| Total Regulated Operating Revenues | 2,717,833 | 2,669,139 |
| Less: |  |  |
| Regulated purchased water expense\* | 117,801 | 119,692 |
| Plus: |  |  |
| Impact of West Virginia Freedom Industries chemical spill | — | 1,012 |
| Estimated impact of weather (mid-point of range) | — | 16,785 |
| Adjusted Regulated Operating Revenues (b) | $2,600,032 | $2,567,244 |
| Adjusted Regulated Operation and Maintenance Efficiency Ratio (a)/(b) | 35.8% | 36.8% |

\* Calculation assumes purchased water revenues approximate purchased water expenses.

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

*(In thousands, except per share amounts)*

|  | For the Three Months Ended September 30, 2015 | 2014 | Favorable (Unfavorable) Change | For the Nine Months Ended September 30, 2015 | 2014 | Favorable (Unfavorable) Change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating revenues | $896,206 | $846,169 | $50,037 | $2,376,405 | $2,279,950 | $96,455 |
| Operating expenses |  |  |  |  |  |  |
| Operation and maintenance | 363,610 | 341,348 | (22,262) | 1,024,066 | 1,004,377 | (19,689) |
| Depreciation and amortization | 111,196 | 106,789 | (4,407) | 327,496 | 318,398 | (9,098) |
| General taxes | 60,292 | 60,807 | 515 | 184,210 | 178,276 | (5,934) |
| Gain on asset dispositions and purchases | (175) | (60) | 115 | (2,512) | (616) | 1,896 |
| Total operating expenses, net | 534,923 | 508,884 | (26,039) | 1,533,260 | 1,500,435 | (32,825) |
| Operating income | 361,283 | 337,285 | 23,998 | 843,145 | 779,515 | 63,630 |
| Other income (expenses) |  |  |  |  |  |  |
| Interest, net | (77,636) | (75,445) | (2,191) | (228,730) | (222,673) | (6,057) |
| Allowance for other funds used during construction | 3,571 | 2,805 | 766 | 8,766 | 7,064 | 1,702 |
| Allowance for borrowed funds used during construction | 2,168 | 1,570 | 598 | 6,232 | 4,324 | 1,908 |
| Amortization of debt expense | (2,112) | (1,669) | (443) | (5,754) | (4,971) | (783) |
| Other, net | (189) | (733) | 544 | 555 | (2,591) | 3,146 |
| Total other income (expenses) | (74,198) | (73,472) | (726) | (218,931) | (218,847) | (84) |
| Income from continuing operations before income taxes | 287,085 | 263,813 | 23,272 | 624,214 | 560,668 | 63,546 |
| Provision for income taxes | 113,191 | 107,205 | (5,986) | 247,202 | 224,773 | (22,429) |
| Income from continuing operations | 173,894 | 156,608 | 17,286 | 377,012 | 335,895 | 41,117 |
| Loss from discontinued operations, net of tax | — | (4,423) | 4,423 | — | (6,288) | 6,288 |
| Net income | $173,894 | $152,185 | $21,709 | $377,012 | $329,607 | $47,405 |
| Basic earnings per share: (a) |  |  |  |  |  |  |
| Income from continuing operations | $0.97 | $0.87 |  | $2.10 | $1.88 |  |
| Loss from discontinued operations, net of tax | $0.00 | $(0.02) |  | $0.00 | $(0.04) |  |
| Net income | $0.97 | $0.85 |  | $2.10 | $1.84 |  |
| Diluted earnings per share: (a) |  |  |  |  |  |  |
| Income from continuing operations | $0.96 | $0.87 |  | $2.09 | $1.87 |  |
| Loss from discontinued operations, net of tax | $0.00 | $(0.02) |  | $0.00 | $(0.03) |  |
| Net income | $0.96 | $0.85 |  | $2.09 | $1.83 |  |
| Average common shares outstanding during the period: |  |  |  |  |  |  |
| Basic | 179,578 | 178,992 |  | 179,534 | 178,800 |  |
| Diluted | 180,353 | 179,948 |  | 180,346 | 179,723 |  |
| (a) Amounts may not sum due to rounding. |  |  |  |  |  |  |

25

The following is a discussion of the consolidated results of operations for the three and nine months ended September 30, 2015 compared to the same periods in 2014:

#### Three Months Ended September 30, 2015 Compared to Three Months Ended September 30, 2014

***Operating revenues.*** Consolidated operating revenues for the quarter ended September 30, 2015 increased $50.0 million, or 5.9%, compared to the same quarter last year. Revenues in our Regulated Businesses segment rose $27.0 million, which was mainly attributable to increases in rates, infrastructure charges and increased demand, partially offset by decreased surcharges and balancing accounts in 2015. Revenues in our Market-Based Businesses segment rose $23.4 million, largely driven by incremental revenue from our military contracts due to increased construction type projects and the addition of two military bases in the second half of 2014 coupled with contract growth in our Homeowner Services (“HOS”) line of business and revenues as a result of the Keystone Acquisition in the third quarter of 2015. For further information, see the respective “Operating Revenues” discussions within the “Segment Results.”

***Operation and maintenance.*** Consolidated O&M increased by $22.3 million, or 6.5%, compared to the same period in 2014 which was primarily attributable to an increase of $21.0 million in O&M costs associated with our Market-Based Businesses segment, principally due to increased activity under our military contracts associated with the operating revenue increase discussed above, incremental costs in HOS resulting from contract growth and the addition of O&M costs as a result of the Keystone acquisition. For further information on the changes in our Regulated Businesses and Market-Based Businesses segments’ O&M, see the respective “Operation and Maintenance” discussions within the “Segment Results” section below.

***Depreciation and amortization.*** Depreciation and amortization expense increased by $4.4 million, or 4.1%, primarily as a result of additional utility plant placed in service.

***Other income (expenses).*** Other expenses increased by $0.7 million, or 1.0%, compared to the same period in 2014. The increase is primarily due to an increase in interest expense, mainly as a result of a $550 million debt issuance in the third quarter of 2015, partially offset by higher allowance for funds used during construction in 2015.

***Provision for income taxes.*** Our consolidated provision for income taxes increased $6.0 million, or 5.6%, to $113.2 million for the three months ended September 30, 2015, due to the increase in pre-tax income. The effective tax rate for the three months ended September 30, 2015 and 2014 was 39.4% and 40.6%, respectively. Included in the three months ended September 30, 2014 were $2.1 million of discrete tax charges associated with uncertain tax positions.

***Loss from discontinued operations, net of tax.*** We disposed of our Terratec line of business, which was previously reported in our Market-Based Businesses segment, in the fourth quarter of 2014. These results were classified as discontinued operations for all periods presented. For the three months ended September 30, 2014, the loss from discontinued operations, net of tax, represents the operating results of Terratec for the period, costs associated with the then pending sale and an income tax valuation allowance.

#### Nine Months Ended September 30, 2015 Compared to Nine Months Ended September 30, 2014

***Operating revenues.*** Consolidated operating revenues for the nine months ended September 30, 2015 increased $96.5 million, or 4.2%, compared to the same period last year. Revenues in our Market-Based Businesses segment rose $54.0 million, largely driven by incremental revenue from our military contracts due to increased construction type project activity and the addition of two military bases in the second half of 2014 coupled with contract growth in HOS and additional operating revenues attributable to the Keystone Acquisition. Revenues in our Regulated Businesses segment rose $43.5 million mainly attributable to rate increases, infrastructure charges and increased demand, partially offset by decreased surcharges and balancing accounts in 2015. For further information, see the respective “Operating Revenues” discussions within the “Segment Results” section below.

***Operation and maintenance.*** Consolidated O&M increased by $19.7 million, or 2.0%, compared to the same period in 2014. This increase was primarily attributable to an additional $48.0 million in O&M costs in our Market-Based Businesses segment, principally due to increased activity related to our military contracts, as noted in the operating revenue discussion above, incremental costs in the HOS line of business and the addition of O&M costs as a result of the Keystone Acquisition. Partially offsetting the increase were lower O&M costs in our Regulated Businesses segment of $26.6 million from continued cost management, lower production and authorized recovery of costs as a result of the finalization of our California general rate case in the first quarter of 2015. Also, included in the 2014 results were incremental costs of $10.3 million associated with the Freedom Industries chemical spill, primarily included in operating supplies and services and other O&M expenses. For further information on the changes in our Regulated Businesses and Market-Based Businesses segments’ O&M, see the respective “Operation and Maintenance” discussions within the “Segment Results” section below.

***Depreciation and amortization.*** Depreciation and amortization expense increased by $9.1 million, or 2.9%, primarily as a result of additional utility plant placed in service.

***General taxes.*** General taxes increased $5.9 million, or 3.3%, primarily due to incremental business and occupation taxes and higher property tax assessments for various subsidiaries in our Regulated Businesses segment.

***Other income (expenses).*** Other expenses increased by $0.1 million, compared to the same period in 2014. The increase was primarily due to incremental interest expense from additional debt issuances, including the $550.0 million debt issuance in the third quarter of 2015. Partially offsetting the increases was incremental income as a result of the authorization through the California rate case of a sharing mechanism between shareholders and customers for prior chemical contamination settlement proceeds of $4.1 million and the recovery of the allowance for borrowed funds used during construction on authorized business transformation project costs.

***Provision for income taxes.*** Our consolidated provision for income taxes increased $22.4 million, or 10.0%, to $247.2 million for the nine months ended September 30, 2015, due to the increase in pre-tax income. The effective tax rates for the nine months ended September 30, 2015 and 2014 were 39.6% and 40.1%, respectively. Included in the nine months ended September 30, 2014 were $2.0 million of discrete tax charges associated with uncertain tax positions.

***Loss from discontinued operations, net of tax.*** We disposed of our Terratec line of business, which was previously reported in our Market-Based Businesses segment, in the fourth quarter of 2014. These results were classified as discontinued operations for all periods presented. The disposition of Terratec was finalized in the fourth quarter of 2014. For the nine months ended September 30, 2014, the loss from discontinued operations, net of tax, represents the operating results of Terratec for the period, the cost of the then pending sale and an income tax valuation allowance.

### Segment Results

We have two reportable segments: the Regulated Businesses and the Market-Based Businesses segments. 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 Segment for the periods indicated:

*(In thousands)*

|  | For the Three Months Ended September 30, 2015 | 2014 | Increase (Decrease) | For the Nine Months Ended September 30, 2015 | 2014 | Increase (Decrease) |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating revenues | $780,729 | $753,701 | $27,028 | $2,082,950 | $2,039,446 | $43,504 |
| Operation and maintenance expense | 277,051 | 278,276 | (1,225) | 813,660 | 840,224 | (26,564) |
| Operating expenses, net | 437,964 | 434,912 | 3,052 | 1,290,551 | 1,302,298 | (11,747) |
| Income from continuing operations before income taxes | 283,632 | 258,539 | 25,093 | 616,530 | 555,985 | 60,545 |

***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 state economic regulation and our results of operations are impacted significantly by rates authorized by the state regulatory commissions in the states in which we operate.

Operating revenues increased by $27.0 million, or 3.6%, for the three months ended September 30, 2015 and increased by $43.5 million, or 2.1%, for the nine months ended September 30, 2015. The increase for the three months ended September 30, 2015 compared to the same period in 2014 is primarily due to incremental revenues of $18.6 million associated with higher demand. We attribute this increase to overall milder weather conditions in 2014 compared to 2015. In the third quarter of 2015, weather conditions varied across our regulated states. We experienced higher revenues from hot and dry conditions in our Northeast region which were offset by lower revenues from wet and milder conditions in our Central region. Also, contributing to the increase in revenue was $10.0 million attributable to rate increases, including infrastructure charges, obtained through rate authorizations for a number of our operating companies, and $2.7 million attributable to acquisitions and organic growth. The balance of the increase is mainly due to incremental revenues from other, sewer, fire and other operating revenues. Partially offsetting these increases was a $12.0 million reduction in revenues from balancing accounts, most of which was the result of the California drought and the corresponding reduction in production costs. Also, included in the $12.0 million reduction in revenues was a $5.1 million charge associated with the

July 2015 application filed by our California subsidiary with the CPUC which requested a change to the present rate design and the emergency conservation and rationing plan for water customers in certain areas within our Monterey county service district.

The increase for the nine months ended September 30, 2015 compared to the same period in 2014 is principally due to incremental revenues of approximately $27.6 million attributable to rate increases, including infrastructure surcharges. Also contributing to the increase was $18.0 million associated with higher demand, as described above, $4.5 million attributable to acquisitions and organic growth. The remaining increase is due to incremental revenues generated from other, sewer, fire and other operating revenues. Partially offsetting these increases were a $16.1 million reduction in revenues from balancing accounts primarily related to the California drought and corresponding reduction in production costs. Also, included in the $16.0 million reduction in revenues was a $5.1 million charge associated with the July 2015 application filed by our California subsidiary discussed above.

The following table sets forth information regarding the Regulated Businesses’ revenues and billed water sales volume by customer class for the periods indicated:

| Customer Class Water service | For the Three Months Ended September 30, 2015 2014 Increase (Decrease) Percentage Operating Revenues (Dollars in thousands) | 2015 2014 Increase (Decrease) Percentage Billed Water Sales Volume (Gallons in millions) |
| --- | ---: | ---: |
| Residential | $434,393 $431,906 $2,487 0.6% | 53,391 53,523 (132) (0.2%) |
| Commercial | 158,737 155,761 2,976 1.9% | 24,259 23,758 501 2.1% |
| Industrial | 35,540 35,349 191 0.5% | 10,869 10,997 (128) (1.2%) |
| Public and other | 88,810 87,868 942 1.1% | 14,142 14,453 (311) (2.2%) |
| Other water revenues | 15,151 12,458 2,693 21.6% | — — — — |
| Billed water services | 732,631 723,342 9,289 1.3% | 102,661 102,731 (70) (0.1%) |
| Unbilled water services | 9,112 (6,012) 15,124 (251.6%) |  |
| Total water service revenues | 741,743 717,330 24,413 3.4% |  |
| Wastewater service revenues | 24,761 23,059 1,702 7.4% |  |
| Other revenues | 14,225 13,312 913 6.9% |  |
|  | $780,729 $753,701 $27,028 3.6% |  |
|  | **For the Nine Months Ended September 30,** |  |
|  | **2015** **2014** **Increase (Decrease)** **Percentage** | **2015** **2014** **Increase (Decrease)** **Percentage** |
|  | **Operating Revenues (Dollars in thousands)** | **Billed Water Sales Volume (Gallons in millions)** |
| **Customer Class** |  |  |
| Water service |  |  |
| Residential | $1,154,700 $1,150,336 $4,364 0.4% | 132,771 135,165 (2,394) (1.8%) |
| Commercial | 416,966 416,197 769 0.2% | 61,276 61,839 (563) (0.9%) |
| Industrial | 98,530 100,337 (1,807) (1.8%) | 29,439 30,403 (964) (3.2%) |
| Public and other | 247,960 253,127 (5,167) (2.0%) | 38,868 40,372 (1,504) (3.7%) |
| Other water revenues | 31,341 21,057 10,284 48.8% | — — — — |
| Billed water services | 1,949,497 1,941,054 8,443 0.4% | 262,354 267,779 (5,425) (2.0%) |
| Unbilled water services | 21,267 (8,973) 30,240 337.0% |  |
| Total water service revenues | 1,970,764 1,932,081 38,683 2.0% |  |
| Wastewater service revenues | 72,749 69,721 3,028 4.3% |  |
| Other revenues | 39,437 37,644 1,793 4.8% |  |
|  | $2,082,950 $2,039,446 $43,504 2.1% |  |

28

*Water Services –* Consistent with the discussion above, water service operating revenues for the three months ended September 30, 2015 totaled $741.7 million, a $24.4 million increase, or 3.4%, over the same period of 2014. For the nine months ended September 30, 2015, these revenues increased $38.7 million, or 2.0%, compared to the nine months ended September 30, 2014. As described above, the increases for both the three and nine months are primarily due to rate increases and infrastructure charges partially offset by a reduction in revenues attributable to balancing accounts. Also, contributing to the incremental revenue for the three months ended September 30, 2015 compared to the same period last year was higher demand for residential and commercial customers. The correlation between water service revenues and billed water sales volumes shown above is impacted by the California drought. California is experiencing a severe drought and in April 2015, the Governor of that state mandated water usage restrictions to reduce overall water usage by 25% in the state compared to 2013 levels. Our California customers are largely meeting the conservation targets. Revenue in California is decoupled from sales volume, aligning our water conservation goals with those of the state and our customers and therefore these usage reductions do not impact earnings. Excluding the impact of the volume reductions in California, volumes for our residential customers increased 2.2% and 0.1% for the three and nine months ended September 30, 2015, and commercial customers increased 4.5 % for the quarter and 0.9% for the nine months ended September 30, 2015. Also, the mix between billed and unbilled water revenue for the nine-month period ended September 30, 2015, compared to the same period in 2014, has changed. This change is principally the result of addressing the majority of delayed customer billings that existed at December 31, 2013, by billing those customers in the first quarter of 2014. The delayed billings resulted from the implementation of our Customer Information System in 2013.

*Wastewater services –* Our subsidiaries provide wastewater services in eleven states. Revenues from these services increased $1.7 million, or 7.4%, and $3.0 million, or 4.3%, for the three and nine months ended September 30, 2015, respectively, compared to the same periods in 2014, mainly as the result of adding additional systems through acquisitions.

*Other revenues –* Other revenues, which include reconnection charges, initial application service fees, certain rental revenues, revenue collection services for others and other similar items, increased $0.9 million, or 6.9%, for the three months ended September 30, 2015. The increase for the nine months ended September 30, 2015, of $1.8 million, or 4.8%, is primarily due to incremental revenues for late payment fees and reconnection fees partially offset by the inclusion in 2014 of $2.4 million of insurance proceeds for business interruption as a result of Hurricane Sandy.

***Operation and maintenance expense.*** Operation and maintenance expense decreased $1.2 million, or 0.4%, and $26.6 million, or 3.2% for the three and nine months ended September 30, 2015, respectively, compared to the same period in 2014.

The following table provides information regarding operation and maintenance expense for the three and nine months ended September 30, 2015 and 2014, by major expense category:

*(Dollars in thousands)*

|  | For the Three Months Ended September 30, 2015 | 2014 | Increase (Decrease) | Percentage | For the Nine Months Ended September 30, 2015 | 2014 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Production costs | $79,657 | $79,455 | $202 | 0.3% | $215,661 | $222,855 | $(7,194) | (3.2%) |
| Employee-related costs | 105,537 | 106,672 | (1,135) | (1.1%) | 320,943 | 321,452 | (509) | (0.2%) |
| Operating supplies and services | 48,363 | 53,204 | (4,841) | (9.1%) | 143,543 | 163,460 | (19,917) | (12.2%) |
| Maintenance materials and supplies | 14,351 | 15,421 | (1,070) | (6.9%) | 50,401 | 53,581 | (3,180) | (5.9%) |
| Customer billing and accounting | 15,916 | 15,420 | 496 | 3.2% | 44,631 | 44,707 | (76) | (0.2%) |
| Other | 13,227 | 8,104 | 5,123 | 63.2% | 38,481 | 34,169 | 4,312 | 12.6% |
| Total | $277,051 | $278,276 | $(1,225) | (0.4%) | $813,660 | $840,224 | $(26,564) | (3.2%) |

29

Production costs by major expense type were as follows:

*(Dollars in thousands)*

|  | For the Three Months Ended September 30, 2015 | 2014 | Increase (Decrease) | Percentage | For the Nine Months Ended September 30, 2015 | 2014 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Purchased Water | $32,767 | $33,674 | $(907) | (2.7%) | $89,832 | $93,332 | $(3,500) | (3.8%) |
| Fuel and Power | 26,560 | 25,890 | 670 | 2.6% | 69,272 | 71,025 | (1,753) | (2.5%) |
| Chemicals | 14,577 | 12,521 | 2,056 | 16.4% | 36,533 | 35,316 | 1,217 | 3.4% |
| Waste Disposal | 5,753 | 7,370 | (1,617) | (21.9%) | 20,024 | 23,182 | (3,158) | (13.6%) |
| Total | $79,657 | $79,455 | $202 | 0.3% | $215,661 | $222,855 | $(7,194) | (3.2%) |

Production costs increased by $0.2 million for the three months ended September 30, 2015 compared to the same period last year. Chemical costs increased by $2.1 million in the quarter as 2014 included recognition of prior contamination proceeds authorized in a rate case for one of our operating subsidiaries. This increase was offset by lower waste disposal costs due to a change in the amount allowed by a cost recovery mechanism in one of our operating companies.

For the nine months ended September 30, 2015, production costs decreased by $7.2 million, or 3.2% compared to the same period last year and was primarily due to decreases in purchased water, principally from lower usage in our California subsidiary, fuel and power due to lower fuel and natural gas prices, and lower waste disposal costs partially offset by higher chemical expenses. Purchased water and fuel and power costs in California are recorded in a balancing account and therefore do not impact earnings. The decrease in waste disposal costs was attributable to the aforementioned change in the amount allowed by a cost recovery mechanism.

The following table provides information with respect to components of employee-related costs for the three and nine months ended September 30, 2015 and 2014:

*(Dollars in thousands)*

|  | For the Three Months Ended September 30, 2015 | 2014 | Increase (Decrease) | Percentage | For the Nine Months Ended September 30, 2015 | 2014 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Salaries and wages | $78,653 | $81,456 | $(2,803) | (3.4%) | $238,133 | $245,107 | $(6,974) | (2.8%) |
| Pensions | 7,428 | 6,648 | 780 | 11.7% | 22,494 | 20,268 | 2,226 | 11.0% |
| Group insurance | 14,843 | 13,759 | 1,084 | 7.9% | 45,648 | 41,889 | 3,759 | 9.0% |
| Other benefits | 4,613 | 4,809 | (196) | (4.1%) | 14,668 | 14,188 | 480 | 3.4% |
| Total | $105,537 | $106,672 | $(1,135) | (1.1%) | $320,943 | $321,452 | $(509) | (0.2%) |

Overall, employee-related costs decreased for both the three and nine months ended September 30, 2015 compared to the same periods in 2014. Salaries and wages decreased for the three and nine months ended September 30, 2015 due to a reduction in headcount and an increase in capital projects which in turn resulted in higher capitalization rates. Also contributing to the reduction in costs was lower severance costs in 2015 as the 2014 costs included incremental costs associated with the restructuring of certain organizational functions. Pension costs and postretirement benefit costs (which is included in the group insurance line above) increased for both the quarter and nine months principally due to the adoption of new mortality assumptions and a decrease in the discount rate, which resulted in increased plan obligations.

Operating supplies and services include expenses for office operation, legal and professional services, transportation expenses, and information systems and other office equipment rental charges. The following table provides information with respect to components of operating supplies and services for the three and nine months ended September 30, 2015 compared to the same periods in 2014.

30

*(Dollars in thousands)*

|  | For the Three Months Ended September 30, 2015 | 2014 | Increase (Decrease) | Percentage | For the Nine Months Ended September 30, 2015 | 2014 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Contracted services | $20,070 | $22,711 | $(2,641) | (11.6%) | $60,569 | $66,173 | $(5,604) | (8.5%) |
| Office supplies and services | 11,349 | 11,382 | (33) | (0.3%) | 32,500 | 34,538 | (2,038) | (5.9%) |
| Transportation | 4,746 | 4,862 | (116) | (2.4%) | 12,345 | 15,143 | (2,798) | (18.5%) |
| Rents | 3,316 | 3,678 | (362) | (9.8%) | 10,850 | 11,509 | (659) | (5.7%) |
| Other | 8,882 | 10,571 | (1,689) | (16.0%) | 27,279 | 36,097 | (8,818) | (24.4%) |
| Total | $48,363 | $53,204 | $(4,841) | (9.1%) | $143,543 | $163,460 | $(19,917) | (12.2%) |

The decrease for the three months ended September 30, 2015 was primarily due to lower contracted services and conservation expense. The decrease for the nine months ended September 30, 2015 compared to the same period in 2014 was primarily due to a reduction in contracted services, lower transportation costs attributable to lower fuel prices and leased vehicle costs, incremental costs in 2014 associated with the Freedom Industries chemical spill in West Virginia of $2.7 million and decreased condemnation-related costs. The decrease for the nine months ended September 30, 2015 also included a $3.2 million adjustment in the first quarter of 2015 attributable to the recovery of previously expensed business transformation costs as a result of the finalization of our California rate case.

Maintenance materials and supplies, which include preventive maintenance and emergency repair costs, decreased $1.1 million, or 6.9%, and $3.2 million, or 5.9%, for the three and nine months ended September 30, 2015, respectively, compared to the same periods in 2014. The decrease for the nine months is primarily due to lower paving, backfilling and other repair costs. These repair costs were higher in the first quarter of 2014 as compared to the same period in 2015 due to higher than normal main breaks as a result of the abnormally severe winter weather conditions experienced in certain states.

Other operation and maintenance expense includes casualty and liability insurance premiums and regulatory costs. The increase for both the three and nine months ended September 30, 2015 compared to the comparable periods in the prior year was primarily driven by increased casualty insurance costs in the third quarter of 2015, as a result of an increase in historical claims experience resulting in premium adjustments. The premium adjustments are based upon current facts and circumstances with respect to outstanding claims and are subject to change as the claims mature.

***Operating expenses.*** The increase in operating expenses for the three months ended September 30, 2015 is principally due to higher depreciation and amortization expense from additional utility plant placed in service partially offset by the decrease in operation and maintenance expense explained above and lower general taxes mainly due to decreased property taxes for certain of our operating companies. The decrease in the nine months ended September 30, 2015 compared to the same period in the prior year is mainly due to the decrease in operation and maintenance expense explained above offset by higher depreciation and amortization expense from additional utility plant placed in service and incremental general taxes primarily due to increased property and gross receipts taxes for certain of our operating companies.

### Market-Based Businesses

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

*(In thousands)*

|  | For the Three Months Ended September 30, 2015 | 2014 | Increase (Decrease) | For the Nine Months Ended September 30, 2015 | 2014 | Increase (Decrease) |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating revenues | $120,373 | $96,980 | $23,393 | $307,822 | $253,857 | $53,965 |
| Operation and maintenance expense | 98,360 | 77,401 | 20,959 | 252,480 | 204,460 | 48,020 |
| Operating expenses, net | 101,573 | 79,915 | 21,658 | 260,449 | 212,075 | 48,374 |
| Income from continuing operations before income taxes | 20,666 | 17,634 | 3,032 | 50,460 | 43,593 | 6,867 |

***Operating revenues.*** Revenues for the three and nine months ended September 30, 2015 increased $23.4 million and $54.0 million, respectively, compared to the same periods in 2014, as a result of incremental revenues in our MSG and HOS lines of business and from the Keystone Acquisition. For the three and nine months ended September 30, 2015, MSG revenue increased $10.9 million and $35.4 million, respectively, primarily from additional construction project activities and the addition of two new military contracts, Hill Air Force Base and Picatinny Arsenal, in the second half of 2014. HOS revenues increased $3.8 million and $10.8 million for the three and nine months ended September 30, 2015, respectively, principally from contract growth, mainly through our New York City contracts and expansion into other geographic areas. Also, contributing to the increase for both the three and nine months ended September 30, 2015 was incremental revenues of $10.0 million related to the Keystone Acquisition.

***Operation and maintenance.*** Operation and maintenance expense increased $21.0 million, or 27.1%, and $48.0 million, or 23.5% for the three and nine months ended September 30, 2015, 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, 2015 | 2014 | Increase (Decrease) | Percentage | For the Nine Months Ended September 30, 2015 | 2014 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Production costs | $9,136 | $8,511 | $625 | 7.3% | $27,052 | $26,372 | $680 | 2.6% |
| Employee-related costs | 19,820 | 15,993 | 3,827 | 23.9% | 52,655 | 45,069 | 7,586 | 16.8% |
| Operating supplies and services | 53,273 | 38,836 | 14,437 | 37.2% | 126,250 | 93,518 | 32,732 | 35.0% |
| Maintenance materials and supplies | 14,016 | 12,443 | 1,573 | 12.6% | 41,453 | 34,753 | 6,700 | 19.3% |
| Other | 2,115 | 1,618 | 497 | 30.7% | 5,070 | 4,748 | 322 | 6.8% |
| Total | $98,360 | $77,401 | $20,959 | 27.1% | $252,480 | $204,460 | $48,020 | 23.5% |

As noted in the table above, employee-related costs increased $3.8 million for the quarter and $7.6 million year-to-date compared to the prior year periods. The Keystone Acquisition added $3.1 million in employee-related costs for both the quarter and the nine months ended September 30, 2015. The year-to-date increase also includes incremental costs associated with construction-type activities and the two new military contracts.

Operating supplies and services increased $14.4 million and $32.7 million, for the three and nine months ended September 30, 2015, compared to the same periods in the prior year, mainly corresponding to contract growth in both the MSG and HOS lines of business, as well as military construction project activities. Also contributing to the increase was the acquisition of Keystone, which added $6.1 million to operating supplies and services for both the three and nine months ended September 30, 2015.

Maintenance materials and supplies increased $6.7 million for the year-to-date period primarily from higher HOS claim costs, which are associated with new contracts.

### 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 Form 10-K.

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 American Water Capital Corp. (“AWCC”), our wholly owned financing subsidiary, issue commercial paper, which is supported by an unsecured revolving credit facility. Indebtedness under the credit facility is considered “debt” for purposes of a support agreement between American Water and AWCC, which serves as a functional equivalent of a guarantee by American Water of AWCC’s payment obligations under the 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.

On June 30, 2015, we, AWCC and the lenders amended and restated our outstanding credit agreement, dated as of October 29, 2012, associated with the revolving credit facility, to extend the expiration date of the facility from October 2018 to June 2020 and to allow AWCC to request to extend further the term of the credit facility for up to two one-year periods. An extension request must satisfy certain conditions and receive approval of the lenders, as set forth in the agreement. The financial covenants with respect to the credit facility remained unchanged.

As of September 30, 2015, AWCC had no outstanding borrowings and $83.4 million of outstanding letters of credit under the revolving credit facility. As of September 30, 2015, AWCC had $1.2 billion available under the credit facility to fulfill our short-term liquidity needs, to issue letters of credit and support $379.9 million in outstanding commercial paper. We can provide no assurances that the lenders will meet their existing commitments to AWCC under the credit facility or that we will be able to access the commercial paper or loan markets in the future on terms acceptable to us or at all.

As noted in our Form 10-K, in February 2015, our Board of Directors authorized an anti-dilutive common stock repurchase program to mitigate the dilutive effect of shares issued through our dividend reinvestment, employee stock purchase and executive compensation programs. This program allows us to purchase up to 10 million shares of our common stock over an unrestricted period of time. We may effect repurchases in the open market or through privately negotiated transactions. We commenced making purchases under this program in April 2015, and through September 30, 2015, we have repurchased an aggregate of 750 thousand shares.

### Cash Flows from Operating Activities

Cash flows from operating activities primarily result from the sale of water and wastewater services and, due to the seasonality of demand, are generally greater during the third quarter of each fiscal year. Cash flows from operating activities for the nine months ended September 30, 2015 were $855.6 million compared to $840.3 million for the nine months ended September 30, 2014.

The following table provides a summary of the major items affecting our cash flows from operating activities for the nine months ended September 30, 2015 and 2014:

*(In thousands)*

|  | For the Nine Months Ended September 30, 2015 | 2014 |
| --- | ---: | ---: |
| Net income | $377,012 | $329,607 |
| Add (subtract): |  |  |
| Non-cash activities (1) | 589,405 | 576,940 |
| Changes in working capital (2) | (70,804) | (30,502) |
| Pension and postretirement healthcare contributions | (39,995) | (35,783) |
| Net cash flows provided by operations | $855,618 | $840,262 |

(1) Includes depreciation and amortization, deferred income taxes and amortization of deferred investment tax credits, provision for losses on accounts receivable, allowance for other funds used during construction, gain on asset dispositions and purchases, pension and non-pension postretirement benefits expense and other non-cash, net. 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 revenues, taxes accrued (including income taxes), accounts payable and accrued expenses and other current assets and liabilities, net.

The increase in cash flows from operating activities during the nine months ended September 30, 2015, as compared to the same period in 2014, reflects higher net income and changes in working capital. The decrease in working capital for the nine months ended September 30, 2015 compared to the same period in the prior year is principally the result of higher cash collections for our Regulated Businesses in the first quarter of 2014, as we delayed some 2013 billings to the first quarter of 2014 when we implemented our new customer information system in 2013. Also, contributing to the decline was a reduction in cash collections from our California utility customers of approximately $23 million due to the continued drought in California. The amounts are collected in balancing accounts and are generally recovered over 12 to 36 months.

### Cash Flows from Investing Activities

The following table provides information regarding cash flows used in investing activities for the nine months ended September 30, 2015 and 2014:

*(In thousands)*

|  | For the Nine Months Ended September 30, 2015 | 2014 |
| --- | ---: | ---: |
| Net capital expenditures | $(791,079) | $(664,871) |
| Proceeds from sale of assets | 4,985 | 804 |
| Acquisitions and related costs | (175,567) | (6,053) |
| Other investing activities, net (1) | (82,321) | (51,221) |
| Net cash flows used in investing activities | $(1,043,982) | $(721,341) |

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

The increase in capital expenditures is principally due to an increase in planned expenditures compared to the prior year and less harsh winter conditions in the first quarter of 2015 compared to the same period in 2014 in certain regions of our Regulated Businesses, which allowed us to increase our capital improvements during the nine months ended September 30, 2015.

The increase in cash utilized for acquisitions during the first nine months of 2015 compared to the same period in 2014 is principally due to the purchase of Keystone and two regulated systems, the Borough of Haddonfield, New Jersey’s water and wastewater systems and the City of Arnold, Missouri’s wastewater system.

We are currently considering a plan to construct a new corporate headquarters to consolidate our support services and certain of our Market-Based Businesses employees within a single location. We are considering several alternatives for the location of the new headquarters. The cost of construction, which would take several years to complete, is currently estimated to be up to $165 million, depending on the location selected and exclusive of any tax incentives that the Company may receive.

### Cash Flows from Financing Activities

The following table provides information regarding cash flows provided by (used in) financing activities for the nine months ended September 30, 2015 and 2014:

*(In thousands)*

|  | For the Nine Months Ended September 30, 2015 | 2014 |
| --- | ---: | ---: |
| Proceeds from long-term debt | $563,727 | $500,497 |
| Repayments of long-term debt | (88,401) | (137,939) |
| Repayments of short-term borrowings | (70,015) | (316,328) |
| Dividends paid | (177,664) | (160,848) |
| Anti-dilutive share repurchase | (39,257) |  |
| Other financing activities, net (1) | 52,118 | 42,861 |
| Net cash flows provided by (used in) financing activities | $240,508 | $(71,757) |

(1) Includes proceeds from issuance of common stock under various employee stock plans and our dividend reinvestment plan, advances and contributions for construction, net of refunds, debt issuance costs and tax benefits realized from equity compensation.

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 and general economic conditions. In addition, new infrastructure may be financed with customer advances (net of refunds) and contributions in aid of construction.

Based on the liquidity and capital needs of American Water and our regulated subsidiaries, AWCC borrows funds on a short-term basis and through intercompany loans, provides the proceeds of those borrowings to the regulated subsidiaries and American Water. The regulated subsidiaries and American Water are obligated to pay to AWCC their respective portion of AWCC’s debt service obligations. Because American Water parent borrowings are not a source of capital for the Company’s regulated subsidiaries, the Company is not able to recover the interest charges on its debt through regulated water and wastewater rates.

We typically utilize commercial paper to meet our short-term liquidity needs, as commercial paper borrowings have historically been a more flexible and lower cost option compared to borrowings under our revolving credit facility. However, we are able to utilize our revolving credit facility to the extent necessary to complement our borrowings in the commercial paper market. In the event of disruptions in the money market sector of the debt capital markets or in response to economic conditions generally, borrowings under our revolving credit facility may be more efficient and a lower cost alternative to commercial paper.

The following long-term debt was issued during the first nine months of 2015:

| Company | Type | Rate | Maturity | Amount |
| --- | --- | --- | --- | ---: |
| American Water Capital Corp. (1) | Senior notes—fixed rate | 3.40%-4.30% | 2025-2045 | $550,000 |
| Other subsidiaries | Private activity bonds and government funded debt—fixed rate | 1.00%-1.56% | 2022-2032 | 13,727 |
| Total issuances |  |  |  | $563,727 |

(1) On August 13, 2015, AWCC completed an offering of its senior fixed rate notes. Proceeds from this offering were used to lend funds to the Company and its regulated utilities, to refinance commercial paper borrowings and to finance redemptions of long-term debt.

The following long-term debt was retired through sinking fund provisions or payment at maturity during the first nine months of 2015:

| Company | Type | Rate | Maturity | Amount (In thousands) |
| --- | --- | ---: | --- | ---: |
| American Water Capital Corp. | Private activity bonds and government funded debt—fixed rate | 1.79%-5.25% | 2015-2031 | $36,442 |
| Other American Water subsidiaries | Private activity bonds and government funded debt—fixed rate | 0.00%-7.45% | 2015-2041 | 50,733 |
| Other American Water subsidiaries | Mandatorily redeemable preferred stock | 8.49% | 2036 | 1,200 |
| Other American Water subsidiaries | Capital lease payments | 12.23% | 2026 | 26 |
| Total retirements and redemptions |  |  |  | $88,401 |

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, consisting of commercial paper, net of discount, amounted to $379.9 million at September 30, 2015.

The following table provides information as of September 30, 2015 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, 2015 | $1,250,000 | $1,166,591 | $150,000 | $66,591 | $379,944 | $— |

The weighted-average interest rate on short-term borrowings for the three months ended September 30, 2015 and 2014 was approximately 0.44% and 0.29%, respectively, and 0.49% and 0.30% for the nine months ended September 30, 2015 and 2014, respectively.

### Capital Structure

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

|  | At September 30, 2015 | At December 31, 2014 |
| --- | ---: | ---: |
| Total common stockholders' equity | 45% | 45% |
| Long-term debt and redeemable preferred stock at redemption value | 52% | 50% |
| Short-term debt and current portion of long-term debt | 3% | 5% |
|  | 100% | 100% |

### Debt Covenants

Our debt agreements contain financial and non-financial covenants. To the extent that we are not in compliance with these covenants, such an event may create an event of default under the debt agreement and 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 under debt agreements with respect to $8.0 million of outstanding debt. We do not believe this event will materially impact us. Our long-term debt indentures also 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. Our failure to comply with any of these covenants could accelerate repayment obligations.

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, 2015, 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, may be directly affected by our securities ratings. We primarily access the debt capital markets, including the commercial paper market, through AWCC. However, we have also issued debt through our regulated subsidiaries, primarily in the form of tax exempt securities or borrowings under state revolving funds, to lower our overall cost of debt.

The following table shows the Company’s securities ratings as of September 30, 2015:

| Securities | Moody’s Investors Service | Standard & Poor’s Ratings Service |
| --- | --- | --- |
| Senior unsecured debt | A3 | A |
| Commercial paper | P2 | A-1 |

On August 7, 2015, Moody’s upgraded the long-term ratings for American Water and AWCC from Baa1 to A3. At the same time, Moody’s also affirmed AWCC’s commercial paper rating at P2. Moody’s rating outlook for American Water and AWCC remains as stable.

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 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

On September 1, 2015, we paid a cash dividend of $0.34 per share to the Company’s shareholders of record as of August 10, 2015.

On October 30, 2015, our board of directors declared a quarterly cash dividend payment of $0.34 per share payable on December 1, 2015 to the Company’s shareholders of record as of November 9, 2015. In 2014, a quarterly cash dividend was declared on September 19, 2014, which was prior to the end of the quarter, with a payment date of December 1, 2014.

Future dividends, declared at the discretion of the Board of Directors, will be dependent upon future earnings, cash flows, financial and legal requirements and other factors.

### 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 a discussion of our critical accounting policies.

### Recent Accounting Pronouncements

See Note 2: New Accounting Pronouncements to our consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for a discussion of new accounting standards recently adopted or pending adoption.

## Market risk

As filed, 380 characters.

We are subject to market risks in the normal course of business, including changes in interest rates and equity prices. There have been no significant changes to our exposure to market risk since December 31, 2014. 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.

## Controls and procedures

As filed, 1,675 characters.

### Evaluation of Disclosure Controls and Procedures

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

Our management, including the Chief Executive Officer and the Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of September 30, 2015.

Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2015, our disclosure controls and procedures were effective at a reasonable level of assurance.

### 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, 2015, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act).

## Risk factors

As filed, 5,125 characters.

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

***Keystone’s operations may expose the Company to substantial costs and liabilities with respect to environmental matters.***

Keystone’s operations, and the operation generally of natural gas and oil exploration and production facilities by Keystone’s customers, are subject to stringent federal, state and local laws, rules, regulations and ordinances governing the release of materials into the environment or otherwise relating to environmental protection. These provisions may require the acquisition by Keystone of permits or licenses before providing its services to customers, prohibit the release of substances defined thereunder as hazardous in connection with these activities, and impose substantial liabilities for the violation thereof that may result from these operations. Failure to comply with these laws, rules, regulations and ordinances may result in substantial environmental remediation and other costs to Keystone, the assessment of administrative, civil and criminal penalties or the issuance of injunctions restricting or prohibiting certain activities. Under existing environmental laws and regulations, Keystone could be held strictly liable for the removal or remediation of previously released materials or property contamination regardless of whether the release resulted from its operations, or whether its operations were in compliance with all applicable laws at the time they were performed. While the Company has attempted to structure and maintain its ownership and control of Keystone’s operations in such a way as to insulate the Company, its regulated subsidiaries and its other market-based operations from any liabilities associated with Keystone’s operations, including liabilities for environmental matters, there can be no assurance that such efforts will be sufficient to prevent the Company from incurring liability for the operations of Keystone.

Changes in environmental laws and regulations occur frequently, and any changes that result in more stringent or costly water or wastewater handling, storage, transport, disposal or cleanup requirements could require Keystone to make significant expenditures to maintain compliance with such requirements, and may otherwise have a material adverse effect on Keystone’s competitive position, financial condition and results of operations.

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

Our total assets include $1.3 billion of goodwill at September 30, 2015. The goodwill is primarily associated with the acquisition of American Water by an affiliate of our previous owner in 2003, the acquisition of E’Town Corporation by a predecessor to our previous owner in 2001, and the acquisition of Keystone which was completed in July 2015. Goodwill represents the excess of the purchase price the purchaser paid over the fair value of the net tangible and other intangible assets acquired. Goodwill is recorded at fair value on the date of an acquisition and is reviewed annually or more frequently if changes in circumstances indicate the carrying value may not be recoverable. As required by the applicable accounting rules, we have taken significant non-cash charges to operating results for goodwill impairments in the past.

We may be required to recognize an impairment of goodwill in the future due to market conditions or other factors related to our performance or the performance of an acquired business. These market conditions could include a decline over a period of time of our stock price, a decline over a period of time in valuation multiples of comparable water utilities, market price performance of our common stock that compares unfavorably to our peer companies, decreases in control premiums, or, with respect to our Keystone operations, fluctuations in the level of exploration and production activities in the Marcellus and Utica shale regions served by Keystone. A decline in the results forecasted in our business plan due to events such as changes in rate case results, capital investment budgets or interest rates, could also result in an impairment charge. Recognition of impairments of a significant portion of goodwill would result in a charge to income in the period in which the impairment occurred, which may negatively affect our reported results of operations and total capitalization. The effects of any such impairment could be material and could make it more difficult to maintain our credit ratings, secure financing on attractive terms, maintain compliance with debt covenants and meet expectations of our regulators.

Filed Nov 4, 2015.
Source: SEC EDGAR, the filing index for accession 0001564590-15-009409. Last ingested by Listed: Nov 4, 2026, 17:16 ET. No prices; not investment advice.