XNYS:AWK American Water Works Co Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to            

Commission file: number 001-34028

 

 

AMERICAN WATER WORKS COMPANY, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   51-0063696

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1025 Laurel Oak Road, Voorhees, NJ   08043
(Address of principal executive offices)   (Zip Code)

(856) 346-8200

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

  

Outstanding at July 26, 2012

Common Stock, $0.01 par value per share

   176,430,023 shares

 

 

 

 


Table of Contents

TABLE OF CONTENTS

AMERICAN WATER WORKS COMPANY, INC.

REPORT ON FORM 10-Q

FOR THE QUARTER ENDED June 30, 2012

INDEX

 

PART I. FINANCIAL INFORMATION

     3   

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

     3   

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     22 – 36   

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     36   

ITEM 4. CONTROLS AND PROCEDURES

     36   

PART II. OTHER INFORMATION

     36   

ITEM 1. LEGAL PROCEEDINGS

     36   

ITEM 1A. RISK FACTORS

     37   

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

     37   

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     37   

ITEM 4. MINE SAFETY DISCLOSURE

     37   

ITEM 5. OTHER INFORMATION

     37   

ITEM 6. EXHIBITS

     37   

SIGNATURES

     38   

EXHIBITS INDEX

  

EXHIBIT 10.1

  

EXHIBIT 31.1

  

EXHIBIT 31.2

  

EXHIBIT 32.1

  

EXHIBIT 32.2

  

EXHIBIT 101

  

 

i


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

American Water Works Company, Inc. and Subsidiary Companies

Consolidated Balance Sheets (Unaudited)

(In thousands, except per share data)

 

     June 30,
2012
    December 31,
2011
 
ASSETS   

Property, plant and equipment

    

Utility plant—at original cost, net of accumulated depreciation of $3,526,087 at June 30 and $3,360,005 at December 31

   $ 11,233,630      $ 10,872,042   

Nonutility property, net of accumulated depreciation of $180,568 at June 30 and $164,417 at December 31

     153,681        149,056   
  

 

 

   

 

 

 

Total property, plant and equipment

     11,387,311        11,021,098   
  

 

 

   

 

 

 

Current assets

    

Cash and cash equivalents

     12,919        14,207   

Restricted funds

     98,698        32,438   

Utility customer accounts receivable

     187,738        150,720   

Allowance for uncollectible accounts

     (13,140     (15,319

Unbilled utility revenues

     161,851        134,938   

Other receivables, net

     63,195        60,413   

Income taxes receivable

     5,822        7,672   

Materials and supplies

     31,712        28,598   

Assets of discontinued operations

     0        929,858   

Other

     57,579        54,134   
  

 

 

   

 

 

 

Total current assets

     606,374        1,397,659   
  

 

 

   

 

 

 

Regulatory and other long-term assets

    

Regulatory assets

     1,139,223        1,079,661   

Restricted funds

     13,103        25,503   

Goodwill

     1,207,572        1,195,069   

Other

     59,178        57,401   
  

 

 

   

 

 

 

Total regulatory and other long-term assets

     2,419,076        2,357,634   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 14,412,761      $ 14,776,391   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3


Table of Contents

American Water Works Company, Inc. and Subsidiary Companies

Consolidated Balance Sheets (Unaudited)

(In thousands, except per share data)

 

     June 30,
2012
    December 31,
2011
 
CAPITALIZATION AND LIABILITIES   

Capitalization

    

Common stock ($.01 par value, 500,000 shares authorized, 176,317 and 175,664 shares outstanding at June 30 and December 31, respectively)

   $ 1,763      $ 1,757   

Paid-in-capital

     6,198,594        6,180,558   

Accumulated deficit

     (1,785,039     (1,848,801

Accumulated other comprehensive loss

     (93,890     (97,677
  

 

 

   

 

 

 

Common stockholders’ equity

     4,321,428        4,235,837   

Preferred stock without mandatory redemption requirements

     4,547        4,547   
  

 

 

   

 

 

 

Total stockholders’ equity

     4,325,975        4,240,384   
  

 

 

   

 

 

 

Long-term debt

    

Long-term debt

     5,203,133        5,339,947   

Redeemable preferred stock at redemption value

     19,275        21,137   
  

 

 

   

 

 

 

Total capitalization

     9,548,383        9,601,468   
  

 

 

   

 

 

 

Current liabilities

    

Short-term debt

     361,972        515,050   

Current portion of long-term debt

     120,289        28,858   

Accounts payable

     183,908        243,709   

Taxes accrued

     39,122        36,606   

Interest accrued

     57,406        59,067   

Liabilities of discontinued operations

     0        382,218   

Other

     255,267        223,597   
  

 

 

   

 

 

 

Total current liabilities

     1,017,964        1,489,105   
  

 

 

   

 

 

 

Regulatory and other long-term liabilities

    

Advances for construction

     377,769        386,970   

Deferred income taxes

     1,434,201        1,288,797   

Deferred investment tax credits

     28,668        29,427   

Regulatory liabilities

     352,550        325,829   

Accrued pension expense

     391,162        411,998   

Accrued postretirement benefit expense

     234,678        237,086   

Other

     38,627        38,963   
  

 

 

   

 

 

 

Total regulatory and other long-term liabilities

     2,857,655        2,719,070   
  

 

 

   

 

 

 

Contributions in aid of construction

     988,759        966,748   

Commitments and contingencies (See Note 10)

     —          —     
  

 

 

   

 

 

 

TOTAL CAPITALIZATION AND LIABILITIES

   $ 14,412,761      $ 14,776,391   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4


Table of Contents

American Water Works Company, Inc. and Subsidiary Companies

Consolidated Statements of Operations and Comprehensive Income (Unaudited)

(In thousands, except per share data)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Operating revenues

   $ 745,607      $ 668,873      $ 1,364,161      $ 1,265,588   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

        

Operation and maintenance

     327,577        327,157        637,581        637,978   

Depreciation and amortization

     92,329        87,342        184,433        174,220   

General taxes

     55,282        52,951        112,403        108,449   

(Gain) loss on asset dispositions and purchases

     (213     28        (626     296   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses, net

     474,975        467,478        933,791        920,943   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     270,632        201,395        430,370        344,645   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expenses)

        

Interest, net

     (79,730     (78,469     (159,384     (154,660

Allowance for other funds used during construction

     5,076        2,535        9,438        5,363   

Allowance for borrowed funds used during construction

     2,313        1,198        4,394        2,402   

Amortization of debt expense

     (1,361     (1,255     (2,627     (2,547

Other, net

     335        680        (281     (475
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expenses)

     (73,367     (75,311     (148,460     (149,917
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     197,265        126,084        281,910        194,728   

Provision for income taxes

     80,602        51,267        115,995        79,212   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     116,663        74,817        165,915        115,516   

Income (loss) from discontinued operations, net of tax

     (9,637     6,293        (17,135     (8,173
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 107,026      $ 81,110      $ 148,780      $ 107,343   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net of tax:

        

Pension plan amortized to periodic benefit cost:

        

Prior service cost, net of tax of $28 and $28 for the three months ended and $56 and $56 for the six months ended, respectively

   $ 44      $ 43      $ 88      $ 87   

Actuarial loss, net of tax of $1,167 and $720 for the three months ended and $2,334 and $1,440 for the six months ended, respectively

     1,826        1,126        3,651        2,252   

Foreign currency translation adjustment

     (211     93        48        411   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

     1,659        1,262        3,787        2,750   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 108,685      $ 82,372      $ 152,567      $ 110,093   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share: (a)

        

Income from continuing operations

   $ 0.66      $ 0.43      $ 0.94      $ 0.66   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from discontinued operations, net of tax

   $ (0.05   $ 0.04      $ (0.10   $ (0.05
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 0.61      $ 0.46      $ 0.84      $ 0.61   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share: (a)

        

Income from continuing operations

   $ 0.66      $ 0.42      $ 0.94      $ 0.66   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from discontinued operations, net of tax

   $ (0.05   $ 0.04      $ (0.10   $ (0.05
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 0.60      $ 0.46      $ 0.84      $ 0.61   
  

 

 

   

 

 

   

 

 

   

 

 

 

Average common shares outstanding during the period:

        

Basic

     176,331        175,469        176,122        175,364   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     177,491        176,419        177,296        176,255   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividends per common share

   $ 0.25      $ 0.45      $ 0.48      $ 0.67   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) Amounts may not sum due to rounding.

The accompanying notes are an integral part of these consolidated financial statements.

 

5


Table of Contents

American Water Works Company, Inc. and Subsidiary Companies

Consolidated Statements of Cash Flows (Unaudited)

(In thousands, except per share data)

 

     Six Months Ended
June 30,
 
     2012     2011  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income

   $ 148,780      $ 107,343   

Adjustments

    

Depreciation and amortization

     184,433        174,220   

Provision for deferred income taxes

     57,833        69,579   

Amortization of deferred investment tax credits

     (759     (771

Provision for losses on utility accounts receivable

     7,402        7,774   

Allowance for other funds used during construction

     (9,438     (5,363

(Gain) loss on asset dispositions and purchases

     (626     296   

Pension and non-pension post retirement benefits

     40,283        35,720   

Other, net

     (18,922     25,475   

Changes in assets and liabilities

    

Receivables and unbilled utility revenues

     (75,541     (44,705

Income taxes receivable

     1,850        (3,443

Other current assets

     665        (35,564

Pension and non-pension post retirement benefit contributions

     (62,591     (72,006

Accounts payable

     (43,252     (14,728

Taxes accrued, including income taxes

     68,804        15,580   

Interest accrued

     (2,051     (1,306

Change in book overdraft

     21,515        0   

Other current liabilities

     (1,514     4,295   
  

 

 

   

 

 

 

Net cash provided by operating activities

     316,871        262,396   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Capital expenditures

     (476,300     (391,792

Acquisitions

     (44,293     (4,769

Proceeds from sale of assets and securities

     560,010        6,657   

Removal costs from property, plant and equipment retirements, net

     (24,634     (24,038

Net restricted funds released

     14,886        38,517   
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     29,669        (375,425
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Proceeds from long-term debt

     14,730        12,275   

Repayment of long-term debt

     (158,188     (64,208

Net (repayments) borrowings under short-term debt agreements

     (119,077     247,946   

Proceeds from issuances of employee stock plans and DRIP

     12,594        8,852   

Advances and contributions for construction, net of refunds of $6,491 and $8,550 at June 30, 2012 and 2011, respectively

     16,720        11,193   

Change in bank overdraft position

     (34,812     (25,411

Debt issuance costs

     0        (552

Redemption of preferred stock

     (1,100     (6

Dividends paid

     (80,943     (77,105

Other

     2,248        399   
  

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (347,828     113,383   
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (1,288     354   

Cash and cash equivalents at beginning of period

     14,207        13,112   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 12,919      $ 13,466   
  

 

 

   

 

 

 

Non-cash investing activity:

    

Capital expenditures acquired on account but unpaid at quarter-end

   $ 93,783      $ 80,573   

Non-cash financing activity:

    

Long-term debt

   $ 68,746      $ 0   

Dividends accrued

   $ 44,079      $ 40,351   

Advances and contributions

   $ 6,188      $ 10,027   

The accompanying notes are an integral part of these consolidated financial statements.

 

6


Table of Contents

American Water Works Company, Inc. and Subsidiary Companies

Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)

(In thousands, except per share data)

 

    

 

 

Common Stock

     Paid-in
Capital
     Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss
   

 

 

Treasury Stock

    Preferred
Stock
of
Subsidiary
Companies
Without
Mandatory
Redemption
Requirements
     Total
Stockholders’
Equity
 
     Shares      Par
Value
            Shares     At Cost       

Balance at December 31, 2011

     175,664       $ 1,757       $ 6,180,558       $ (1,848,801   $ (97,677     0      $ 0      $ 4,547       $ 4,240,384   

Net income

     —           —           —           148,780        —          —          —          —           148,780   

Direct stock reinvestment and purchase plan, net of expense of $6

     30         0         1,022         —          —          —          —          —           1,022   

Employee stock purchase plan

     26         0         1,056         —          —          31       1,046       —           2,102   

Stock-based compensation activity

     597         6         15,958         (399     —          (31     (1,046     —           14,519   

Other comprehensive income, net of tax of $2,390

     —           —           —           —          3,787        —          —          —           3,787   

Dividends

     —           —           —           (84,619     —          —          —          —           (84,619
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at June 30, 2012

     176,317       $ 1,763       $ 6,198,594       $ (1,785,039   $ (93,890     0      $ 0      $ 4,547       $ 4,325,975   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

    

 

 

Common Stock

     Paid-in
Capital
     Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss
   

 

 

Treasury Stock

    Preferred
Stock
of
Subsidiary
Companies
Without
Mandatory
Redemption
Requirements
     Total
Stockholders’
Equity
 
     Shares      Par
Value
            Shares     At Cost       

Balance at December 31, 2010

     174,996       $ 1,750       $ 6,156,675       $ (1,959,235   $ (71,446     (1   $ (19   $ 4,547       $ 4,132,272   

Net income

     —           —           —           107,343        —          —          —          —           107,343   

Direct stock reinvestment and purchase plan, net of expense of $9

     34         0         948         —          —          —          —          —           948   

Employee stock purchase plan

     59         1         1,586         —          —          —          —          —           1,587   

Stock-based compensation activity

     349         3         10,838         (392     —          1        19        —           10,468   

Other comprehensive income, net of tax of $1,496

     —           —           —           —          2,750        —          —          —           2,750   

Dividends

     —           —           —           (117,456     —          —          —          —           (117,456
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at June 30, 2011

     175,438       $ 1,754       $ 6,170,047       $ (1,969,740   $ (68,696     0      $ 0      $ 4,547       $ 4,137,912   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

7


Table of Contents

American Water Works Company, Inc. and Subsidiary Companies

Notes to Consolidated Financial Statements (Unaudited)

(In thousands, except per share data)

Note 1: Basis of Presentation

The accompanying Consolidated Balance Sheet of American Water Works Company, Inc. and Subsidiary Companies (the “Company”) at June 30, 2012, the Consolidated Statements of Operations and Comprehensive Income for the three and six months ended June 30, 2012 and 2011, the Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011, and the Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2012 and 2011, are unaudited, but reflect all adjustments, which are, in the opinion of management, necessary to present fairly the consolidated financial position, the consolidated changes in stockholders’ equity, the consolidated results of operations and comprehensive income, and the consolidated cash flows for the periods presented. All adjustments are of a normal, recurring nature, except as otherwise disclosed. Because they cover interim periods, the unaudited consolidated financial statements and related notes to the consolidated financial statements do not include all disclosures and notes normally provided in annual financial statements and, therefore, should be read in conjunction with the Company’s Consolidated Financial Statements and related Notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the year, due primarily to the seasonality of the Company’s operations.

During the fourth quarter of 2011, the Company discovered errors in the Company’s calculations of gains or losses on discontinued operations that originated in the first and second quarters of 2011. As a result, the Company recorded after-tax charges totaling $24,555, which included associated parent company goodwill, to reduce the net asset values of those businesses to their net realizable values. These charges were recognized within discontinued operations and net income and included in the operating results for the year ended December 31, 2011. In the footnotes to the Consolidated Financial Statements for the period ended December 31, 2011, the Company corrected the presentation of the first and second quarters of 2011. Additionally the Company reflected this correction in the corresponding prior periods presented in the Consolidated Statements of Operations and Comprehensive Income for the three and six-month periods ended June 30, 2012. The write-downs included in the first and second quarters of 2011 totaled $21,099 and $3,456, respectively.

Note 2: New Accounting Pronouncements

The following recently announced accounting standards have been adopted by the Company and have been included in the consolidated results of operations, financial position or footnotes of the accompanying Consolidated Financial Statements:

Fair Value Measurements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued updated accounting guidance related to fair value measurements and disclosures that result in common fair value measurements and disclosures between U.S. Generally Accepted Accounting Principles (“GAAP”) and International Financial Reporting Standards. This new guidance amends current fair value measurement and disclosure guidance to increase transparency around valuation inputs and investment categorization. This guidance is effective for interim and annual periods beginning on January 1, 2012 and is required to be applied prospectively. The adoption of this guidance did not have a significant impact on the Company’s results of operations, financial position or cash flows.

Comprehensive Income

In June 2011, the FASB issued guidance on the presentation of comprehensive income. The new guidance allows an entity to present components of net income and other comprehensive income in either one continuous statement or two separate but consecutive statements. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. While the new guidance changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive income under current accounting guidance. In December 2011, the FASB deferred the requirement to present reclassification adjustments of other comprehensive income on the face of the income statement. The new guidance is effective for the Company beginning on January 1, 2012. As the Company already presents the components of net income and other comprehensive income in one continuous statement, the adoption of the new guidance did not have an impact on its results of operations, financial position or cash flows.

 

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Testing Goodwill for Impairment

In September 2011, the FASB updated the accounting guidance related to testing goodwill for impairment. This update permits an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test that is currently in place. Under the new guidance, an entity will not be required to calculate the fair value of a reporting unit unless the entity determines, based on the qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This update is effective for annual and interim goodwill impairment tests performed by the Company beginning on January 1, 2012. The adoption of this update is not expected to have a significant impact on its results of operations, financial position or cash flows.

Note 3: Acquisitions and Divestitures

Acquisitions

As of June 30, 2012, the Company closed on five acquisitions of various regulated water and wastewater systems for a total aggregate purchase price of $44,293. Included in this total was the Company’s May 1, 2012 acquisition of all of the capital stock of Aqua New York, Inc. (the “Acquisition”) for a total cash purchase price of $39,273 plus assumed liabilities, subject to post-closing purchase price adjustments that may occur during the second half of 2012. The Acquisition, which expanded the Company’s service area in the state of New York, added approximately 50,000 customers to regulated operations.

The Acquisition was accounted for as a business combination; accordingly, operating results from May 1, 2012 were included in the Company’s results of operations. The preliminary purchase price was allocated to the net tangible and intangible assets based upon their estimated fair values at the date of acquisition. The Company’s regulatory practice has been followed whereby property, plant and equipment (rate base) is considered fair value for business combination purposes. Similarly, regulatory assets and liabilities acquired have been recorded at book value and are subject to regulatory approval where applicable. The acquired debt and employee benefit plans have been fair valued using common valuation techniques. The acquired debt has been valued in a manner consistent with the Company’s Level 2 and Level 3 pre-acquisition debt. (See Note 13) The Company has recognized employee benefit plan liabilities on the acquisition date for the funded status of defined-benefit plans assumed as part of the business combination. The pro forma impact of this acquisition would not have been material to the Company’s results of operations for the three and six months ended June 30, 2012 and 2011, respectively. Total assets acquired in the Acquisition were $106,911, including $58,669 of plant, $32,884 of regulatory assets, $2,855 of other assets and $12,503 of goodwill; liabilities assumed totaled $67,638, including long-term debt of $25,215, $15,377 of regulatory liabilities, $15,029 of deferred taxes, $2,307 of other liabilities and $9,710 of pension and postretirement welfare liabilities.

Divestitures

As part of the Company’s strategic review of its business investments, it has previously entered into agreements to sell assets or stock of certain subsidiaries.

In January 2012, the Company completed the close of the sale of its Arizona and New Mexico subsidiaries. Initial sales proceeds were $461,057, and the Company recorded no gain or loss at the time of the sale closing. In June 2012, as part of post-closing adjustments to finalize the sale, the Company remitted $2,448 to the purchaser, and recorded a pretax loss on sale for the same amount.

In May 2012, the Company completed the close of the sale of its Ohio subsidiary. Initial sales proceeds were $101,083 and are subject to post-closing adjustments. The Company recorded a pretax loss on sale of $5,166, primarily due to pension settlement costs calculated at closing.

As disclosed in Note 1 included herein, the Company previously revised its 2011 first quarter results for an after-tax impairment charge of $21,099, which was recorded as an asset impairment charge to reduce parent company goodwill that had been allocated to the Arizona and New Mexico subsidiaries. An additional $3,456 after-tax asset impairment charge was recorded in the Company’s 2011 second quarter results for parent company goodwill allocated to the Ohio subsidiary transaction.

In June 2011, the Company completed the sale of the assets of its Texas subsidiary for sale proceeds of $6,245. In the first quarter of 2011, the Company had previously recognized an after-tax impairment charge of $552 for parent company goodwill allocated to the Texas subsidiary.

Charges recorded in connection with the discontinued operations include estimates that are subject to subsequent adjustments.

A summary of discontinued operations presented in the Consolidated Statements of Operations and Comprehensive Income follows:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012     2011      2012     2011  

Operating revenues

   $ 3,160      $ 45,329       $ 19,377      $ 83,456   

Total operating expenses, net

     15,465        33,101         27,918        81,266   
  

 

 

   

 

 

    

 

 

   

 

 

 

Operating income (loss)

     (12,305     12,228         (8,541     2,190   

Other income (expenses), net

     (47     118         (167     410   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from discontinued operations before income taxes

     (12,352     12,346         (8,708     2,600   

Provision (benefit) for income taxes

     (2,715     6,053         8,427        10,773   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from discontinued operations, net of tax

   $ (9,637   $ 6,293       $ (17,135   $ (8,173
  

 

 

   

 

 

    

 

 

   

 

 

 

 

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There were no assets or liabilities of discontinued operations at June 30, 2012. Assets and liabilities of discontinued operations at December 31, 2011 include the following:

 

Assets:

  

Total property, plant and equipment

   $ 833,023   

Current assets

     21,906   

Regulatory assets

     43,849   

Goodwill

     29,608   

Other

     1,472   
  

 

 

 

Total assets of discontinued operations

   $ 929,858   
  

 

 

 

 

Liabilities:

  

Long-term debt

   $ 11,697   

Current portion of long-term debt

     12,839   

Other current liabilities

     29,530   

Advances for construction

     205,034   

Regulatory liabilities

     4,617   

Other

     15,540   

Contributions in aid of construction

     102,961   
  

 

 

 

Total liabilities of discontinued operations

   $ 382,218   
  

 

 

 

Note 4: Goodwill

The Company’s annual goodwill impairment test is conducted at November 30 of each calendar year. Interim reviews are performed when the Company determines that a triggering event that would more likely than not reduce the fair value of a reporting unit below its carrying value has occurred.

In the first quarter of 2011, the Company assessed fair value, including allocated goodwill, and recorded impairments of $21,099 for the pending sales of its Arizona and New Mexico subsidiaries, and $552 for the pending sale of the Company’s assets of its Texas subsidiary. These impairment charges were included in operating results of discontinued operations. (see Note 3 above)

The following table summarizes the six-month changes in goodwill of the Company’s continuing operations by reporting unit:

 

     Regulated Unit     Market-Based Operations     Consolidated  
     Cost     Accumulated
Impairment
    Cost      Accumulated
Impairment
    Cost     Accumulated
Impairment
    Total Net  

Balance at January 1, 2012

   $ 3,399,368      $ (2,332,670   $ 235,990       $ (107,619   $ 3,635,358      $ (2,440,289   $ 1,195,069   

Goodwill from acquisitions

     12,503        0        0         0        12,503        0        12,503   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2012

   $ 3,411,871      $ (2,332,670   $ 235,990       $ (107,619   $ 3,647,861      $ (2,440,289   $ 1,207,572   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at January 1, 2011

   $ 3,399,884      $ (2,332,670   $ 235,990       $ (107,619   $ 3,635,874      $ (2,440,289   $ 1,195,585   

Reclassifications and other activity

     (75     0        0         0        (75     0        (75
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2011

   $ 3,399,809      $ (2,332,670   $ 235,990       $ (107,619   $ 3,635,799      $ (2,440,289   $ 1,195,510   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

The Company may be required to recognize an impairment of goodwill in the future due to market conditions or other factors related to the Company’s performance. These market events could include a decline over a period of time of the Company’s stock price, a decline over a period of time in valuation multiples of comparable water utilities, the lack of an increase in the Company’s market price consistent with its peer companies, or decreases in control premiums. A decline in the forecasted results in the Company’s business plan, such as changes in rate case results or capital investment budgets or changes in the Company’s interest rates, could also result in an impairment charge. Recognition of impairments of a significant portion of goodwill would negatively affect the Company’s reported results of operations and total capitalization, the effect of which could be material and could make it more difficult to maintain its credit ratings, secure financing on attractive terms, maintain compliance with debt covenants and meet expectations of the Company’s regulators.

 

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Note 5: Stockholders’ Equity

Common Stock

In March 2010, the Company established American Water Stock Direct, a dividend reinvestment and direct stock purchase plan (the “DRIP”). Under the DRIP, stockholders may reinvest cash dividends and purchase additional Company common stock, up to certain limits, through a transfer agent without commission fees. The Company’s transfer agent may buy newly issued shares directly from the Company or shares held in the Company’s treasury. The transfer agent may also buy shares in the public markets or in privately negotiated transactions. Purchases generally will be made and credited to DRIP accounts once each week. As of June 30, 2012, there were 4,843 shares available for future issuance under the DRIP. The following table summarizes information regarding issuances under the DRIP for the six months ended June 30, 2012 and 2011:

 

     2012      2011  

Shares of common stock issued

     30         34   

Cash proceeds received

   $ 1,028       $ 957   

Cash dividend payments made during the three-month periods ended March 31 and June 30 were as follows:

 

     2012      2011  

Dividends per share, three months ended:

     

March 31

   $ 0.23       $ 0.22   

June 30

     0.23         0.22   

Total dividends paid, three months ended:

     

March 31

   $ 40,414       $ 38,525   

June 30

     40,529         38,580   

On May 11, 2012, the Company declared a quarterly cash dividend payment of $0.25 per share payable on September 3, 2012 to all shareholders of record as of July 6, 2012. As of June 30, 2012, the Company had accrued dividends totaling $44,079 included in other current liabilities in the accompanying Consolidated Balance Sheets.

Stock-Based Compensation

The Company has granted stock option and restricted stock unit awards to non-employee directors, officers and other key employees of the Company pursuant to the terms of its 2007 Omnibus Equity Compensation Plan (the “Plan”). As of June 30, 2012, a total of 10,215 shares were available for grant under the Plan. Shares issued under the Plan may be authorized but unissued shares of Company stock or reacquired shares of Company stock, including shares purchased by the Company on the open market for purposes of the Plan.

The Company recognizes compensation expense for stock awards over the vesting period of the award. The following table presents stock-based compensation expense recorded in operation and maintenance expense in the accompanying Consolidated Statements of Operations and Comprehensive Income for the three and six months ended June 30, 2012 and 2011:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Stock options

   $ 860      $ 802      $ 1,706      $ 1,628   

Restricted stock units

     2,014        1,699        3,304        2,904   

Employee stock purchase plan

     121        111        253        208   
  

 

 

   

 

 

   

 

 

   

 

 

 

Stock-based compensation in operation and maintenance expense

     2,995        2,612        5,263        4,740   

Income tax benefit

     (1,169     (1,019     (2,053     (1,849
  

 

 

   

 

 

   

 

 

   

 

 

 

After-tax stock-based compensation expense

   $ 1,826      $ 1,593      $ 3,210      $ 2,891   
  

 

 

   

 

 

   

 

 

   

 

 

 

There were no significant stock-based compensation costs capitalized during the six months ended June 30, 2012 and 2011, respectively.

Stock Options

In the first six months of 2012, the Company granted non-qualified stock options to certain employees under the Plan. The stock options vest ratably over the three-year service period beginning January 1, 2012. These awards have no performance vesting conditions and the grant date fair value is amortized through expense over the requisite service period using the straight-line method. The following table presents the weighted-average assumptions used in the pricing model for 2012 grants and the resulting weighted-average grant date fair value per share of stock options granted:

 

Dividend yield

     2.70

Expected volatility

     28.35

Risk-free interest rate

     0.78

Expected life (years)

     4.4   

Exercise price

   $ 34.14   

Grant date fair value per share

   $ 6.11   

 

 

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Stock options granted under the Plan have maximum terms of seven years, vest over periods ranging from one to three years, and are granted with exercise prices equal to the market value of the Company’s common stock on the date of grant. As of June 30, 2012, $5,243 of total unrecognized compensation cost related to the non-vested stock options is expected to be recognized over the weighted-average period of 1.8 years.

The following table summarizes stock option activity for the six months ended June 30, 2012:

 

     Shares     Weighted-
Average
Exercise Price
(per share)
     Weighted-
Average
Remaining
Life (years)
     Aggregate
Intrinsic
Value
 

Options outstanding at January 1, 2012

     3,112      $ 22.70         

Granted

     649        34.14         

Forfeited or expired

     (68     27.08         

Exercised

     (457     21.68         
  

 

 

         

Options outstanding at June 30, 2012

     3,236      $ 25.05         4.4       $ 29,876   
  

 

 

   

 

 

    

 

 

    

 

 

 

Exercisable at June 30, 2012

     1,921      $ 21.96         3.4       $ 23,665   
  

 

 

   

 

 

    

 

 

    

 

 

 

The following table summarizes additional information regarding stock options exercised during the six months ended June 30, 2012 and 2011:

 

     2012      2011  

Intrinsic value

   $ 5,594       $ 1,893   

Exercise proceeds

     9,896         6,517   

Income tax benefit

     1,443         253   

Restricted Stock Units

In the first six months of 2012, the Company granted restricted stock units to certain employees under the Plan. The restricted stock units vest ratably over the three-year performance period beginning January 1, 2012 (the “Performance Period”); however, distribution of the shares is contingent upon the achievement of internal performance measures and, separately, certain market thresholds over the Performance Period. The restricted stock units granted with performance and service conditions are valued at the market value of the Company’s common stock on the date of grant. The restricted stock units granted with market and service conditions are valued using a Monte Carlo model. Weighted-average assumptions used in the Monte Carlo simulation for the 2012 grants are as follows:

 

Expected volatility

     22.47

Risk-free interest rate

     0.43

Expected life (years)

     3   

The grant date fair value of the restricted stock awards that vest ratably and have market and/or performance and service conditions is amortized through expense over the requisite service period using the graded-vesting method. As of June 30, 2012, $5,948 of total unrecognized compensation cost related to the non-vested restricted stock units is expected to be recognized over the weighted-average remaining life of 1.1 years.

 

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The following table summarizes restricted stock unit activity for the six months ended June 30, 2012:

 

     Shares     Weighted-Average
Grant Date
Fair Value
(per share)
 

Nonvested total at January 1, 2012

     577      $ 25.09   

Granted

     172        37.40   

Vested

     (182     23.01   

Forfeited

     (17     29.69   

Cancelled

     (2     22.08   
  

 

 

   

Nonvested total at June 30, 2012

     548      $ 29.51   
  

 

 

   

The following table summarizes additional information regarding restricted stock units distributed during the six months ended June 30, 2012 and 2011:

 

     2012      2011  

Intrinsic value

   $ 5,804       $ 1,695   

Income tax benefit

     798         99   

If dividends are declared with respect to shares of the Company’s common stock before the restricted stock units are distributed, the Company credits a liability for the value of the dividends that would have been paid if the restricted stock units were shares of Company common stock. When the restricted stock units are distributed, the Company pays the participant a lump sum cash payment equal to the value of the dividend equivalents accrued. The Company accrued dividend equivalents totaling $399 and $392 to retained earnings during the six months ended June 30, 2012 and 2011, respectively.

Employee Stock Purchase Plan

Under the Nonqualified Employee Stock Purchase Plan (the “ESPP”), employees can use payroll deductions to acquire Company stock at the lesser of 90% of the fair market value of (a) the beginning or (b) the end of each three-month purchase period. As of June 30, 2012 there were 1,535 shares of common stock reserved for issuance under the ESPP. During the six months ended June 30, 2012, the Company issued 57 shares under the ESPP.

 

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Note 6: Long-Term Debt

The Company primarily issues long-term debt to fund capital expenditures at the regulated subsidiaries. The components of long-term debt are as follows:

 

     Rate    Weighted-
Average Rate
    Maturity
Date
     June 30,
2012
     December 31,
2011
 

Long-term debt of American Water Capital Corp. (“AWCC”) (a)

             

Private activity bonds and government funded debt

             

Fixed rate

   4.85%-6.75%      5.72     2018-2040       $ 322,610       $ 322,610   

Senior notes

             

Fixed rate

   5.39%-10.00%      6.25     2013-2040         3,089,409         3,089,409   

Long-term debt of other subsidiaries

             

Private activity bonds and government funded debt

             

Fixed rate

   0.00%-6.20%      4.77     2012-2041         1,159,519         1,206,332   

Mortgage bonds

             

Fixed rate

   5.48%-9.71%      7.40     2012-2039         697,800         697,800   

Mandatory redeemable preferred stock

   8.47%-9.75%      8.61     2019-2036         21,001         22,101   

Notes payable and other (b)

   9.49%-12.17%      11.70     2013-2026         1,478         1,691   
          

 

 

    

 

 

 

Long-term debt

             5,291,817         5,339,943   

Unamortized debt discount, net (c)

             43,497         43,888   

Fair value adjustment to interest rate hedge

             7,383         6,111   
          

 

 

    

 

 

 

Total long-term debt

           $ 5,342,697       $ 5,389,942   
          

 

 

    

 

 

 

 

(a) AWCC, which is a wholly-owned subsidiary of the Company, has a strong support agreement with its parent that, under certain circumstances, is the functional equivalent of a guarantee.
(b) Includes capital lease obligations of $1,149 and $1,264 at June 30, 2012 and December 31, 2011, respectively.
(c) Includes fair value adjustments recognized in acquisition purchase accounting.

The following long-term debt was issued in 2012:

 

Company

  

Type

   Interest Rate    Maturity    Amount  

Other subsidiaries (1)

  

Private activity bonds and government funded debt – fixed rate

   0.00%-5.00%    2013-2041    $ 83,476   
           

 

 

 

Total issuances

            $ 83,476   
           

 

 

 

 

(1) Included in the issuance amount above was $68,746, which was initially kept in Trust pending the Company’s certification that it has incurred qualifying capital expenditures. These issuances have been presented as non-cash in the accompanying Consolidated Statements of Cash Flows. Subsequent releases of all or a lesser portion of these funds by the applicable Trust are reflected as the release of restricted funds and are included in investing activities in the accompanying Consolidated Statements of Cash Flows.

The following long-term debt was retired through optional redemption or payment at maturity during 2012:

 

Company

  

Type

   Interest Rate    Maturity    Amount  

Other subsidiaries

  

Mortgage bonds – fixed rate

   7.95%    2012    $ 4,200   

Other subsidiaries

  

Private activity bonds and government funded debt – fixed rate

   0.00%-5.90%    2012-2041      153,775   

Other subsidiaries

  

Mandatory redeemable preferred stock

   4.60%-6.00%    2013-2019      1,100   

Other

  

Capital leases and other

           213   
           

 

 

 

Total retirements and redemptions

            $ 159,288   
           

 

 

 

Other activity of long-term debt during the first six months of 2012 includes debt assumed in an acquisition totaling $25,215 (see Note 3).

On July 2, 2012, the Company redeemed $86,090 of outstanding bonds maturing in 2028 and 2029 with interest rates ranging from 5.00% to 5.10%. In addition, on July 6, 2012 the Company redeemed $2,827 of preferred stock without mandatory redemption requirements with interest rates ranging from 5.00% to 5.75%. The redemptions were made using commercial paper borrowings.

 

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Interest income included in interest, net is summarized below:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

Interest income

   $ 2,821       $ 2,754       $ 5,633       $ 5,403   

The Company previously entered into an interest-rate swap to hedge $100,000 of its 6.085% fixed-rate debt maturing 2017. The Company pays variable interest of six-month LIBOR plus 3.422%. This fixed rate and variable rate interest swap is accounted for as a fair value hedge. The swap matures with the fixed-rate debt in 2017. The Company uses a combination of fixed-rate and variable-rate debt to manage interest rate exposure.

At June 30, 2012 and December 31, 2011, the Company had a $100,000 notional amount variable interest-rate swap fair value hedge outstanding. The following table provides a summary of the derivative fair value balance recorded by the Company and the line item in the Consolidated Balance Sheets in which such amount is recorded:

 

     June 30,
2012
     December 31,
2011
 

Regulatory and other long-term assets

     

Other

   $ 7,088       $ 5,824   

Long-term debt

     

Long-term debt

     7,383         6,111   

For derivative instruments that are designated as and qualify as fair value hedges, the gain or loss on the hedge instrument as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current net income. The Company includes the gain or loss on the derivative instrument and the offsetting loss or gain on the hedged item in interest expense as follows:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     20111  

Interest, net

        

Gain (loss) on swap

   $ 1,497      $ 2,767      $ 1,263      $ 1,614   

Gain (loss) on borrowing

     (1,549     (2,420     (1,272     (1,433

Hedge ineffectiveness

     (52     347        (9     181   

Note 7: Short-Term Debt

The components of short-term debt are as follows:

 

     June 30,
2012
     December 31,
2011
 

Commercial paper, net of $28 and $52 discount at June 30 and December 31, respectively

   $ 361,972       $ 481,048   

Bank overdraft

     0         34,002   
  

 

 

    

 

 

 

Total short-term debt

   $ 361,972       $ 515,050   
  

 

 

    

 

 

 

Prior to January 1, 2012, the Company had overdraft protection provided by a revolving credit line with PNC Bank, N.A. The Company did not renew this credit line at December 31, 2011. Accordingly, the Company’s outstanding checks on its cash accounts with PNC Bank, N.A. are classified, as of January 1, 2012, as other current liabilities in the accompanying Consolidated Balance Sheets, and changes in those accounts are included in operating activities for 2012 in the accompanying Consolidated Statements of Cash Flows.

Note 8: Income Taxes

The Company’s estimated annual effective tax rate for the six months ended June 30, 2012 was 40.2% compared to 40.5% for the six months ended June 30, 2011, excluding various discrete items. The Company’s actual effective tax rates on continuing operations were as follows:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Actual effective tax rate on continuing operations

     40.9     40.7     41.1     40.7

 

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Note 9: Pension and Other Postretirement Benefits

The following table provides the components of net periodic benefit costs:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Components of net periodic pension benefit cost

        

Service cost

   $ 8,507      $ 8,411      $ 17,014      $ 16,821   

Interest cost

     17,521        17,261        35,042        34,523   

Expected return on plan assets

     (19,618     (18,027     (39,237     (36,054

Amortization of:

        

Prior service cost

     180        181        361        361   

Actuarial loss

     7,403        4,637        14,805        9,275   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic pension benefit cost

   $ 13,993      $ 12,463      $ 27,985      $ 24,926   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Components of net periodic other postretirement benefit cost

        

Service cost

   $ 3,525      $ 3,484      $ 7,051      $ 6,969   

Interest cost

     7,858        7,804        15,716        15,609   

Expected return on plan assets

     (7,141     (7,194     (14,281     (14,389

Amortization of:

        

Prior service credit

     (478     (481     (957     (962

Actuarial loss

     2,385        1,784        4,769        3,567   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic other postretirement benefit cost

   $    6,149      $     5,397      $ 12,298      $ 10,794   
  

 

 

   

 

 

   

 

 

   

 

 

 

The Company contributed $47,600 to its defined benefit pension plans in the first six months of 2012 and expects to contribute $49,928 during the balance of 2012. In addition, the Company contributed $14,991 for the funding of its other postretirement plans in the first six months of 2012 and expects to contribute $15,083 during the balance of 2012.

Note 10: Commitments and Contingencies

The Company is routinely involved in legal actions incident to the normal conduct of its business. At June 30, 2012, the Company has accrued approximately $3,200 as probable costs and it is reasonably possible that additional losses could range up to $32,200 for these matters. For certain matters, the Company is unable to estimate possible losses. The Company believes that damages or settlements recovered by plaintiffs in such claims or actions, if any, will not have a material adverse effect on the Company’s results of operations, financial position or cash flows.

The Company enters into agreements for the provision of services to water and wastewater facilities for the United States military, municipalities and other customers. The Company’s military services agreements expire between 2051 and 2060 and have remaining performance commitments as measured by estimated remaining contract revenue of $1,986,000 at June 30, 2012. The military contracts are subject to customary termination provisions held by the U.S. Federal Government prior to the agreed upon contract expiration. The Company’s Operations and Maintenance agreements with municipalities and other customers expire between 2012 and 2048 and have remaining performance commitments as measured by estimated remaining contract revenue of $1,032,000 at June 30, 2012. Some of the Company’s long-term contracts to operate and maintain a municipality’s, federal government’s or other party’s water or wastewater treatment and delivery facilities include responsibility for certain maintenance for some of those facilities, in exchange for an annual fee. Unless specifically required to perform certain maintenance activities, the maintenance costs are recognized when the maintenance is performed.

Note 11: Environmental Matters

The Company’s water and wastewater operations are subject to federal, state, local and foreign requirements relating to environmental protection, and as such, the Company periodically becomes subject to environmental claims in the normal course of business. Environmental expenditures that relate to current operations or provide a future benefit are expensed or capitalized as

 

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appropriate. Remediation costs that relate to an existing condition caused by past operations are accrued, on an undiscounted basis, when it is probable that these costs will be incurred and can be reasonably estimated. Remediation costs accrued amounted to $4,400 and $5,500 at June 30, 2012 and December 31, 2011, respectively. The accrual relates to a conservation agreement entered into by a subsidiary of the Company with the National Oceanic and Atmospheric Administration (“NOAA”) requiring the Company to, among other provisions, implement certain measures to protect the steelhead trout and its habitat in the Carmel River watershed in the state of California. The Company has agreed to pay $1,100 annually from 2010 through 2016. The Company pursues recovery of incurred costs through all appropriate means, including regulatory recovery through customer rates. The Company’s regulatory assets at June 30, 2012 and December 31, 2011 include $9,041 and $9,187 respectively, related to the NOAA agreement.

Note 12: Earnings per Common Share

Earnings per share is calculated using the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security. The Company has participating securities related to restricted stock units, granted under the Company’s 2007 Omnibus Equity Compensation Plan, that earn dividend equivalents on an equal basis with common shares. In applying the two-class method, undistributed earnings are allocated to both common shares and participating securities. The following is a reconciliation of the Company’s income from continuing operations, income (loss) from discontinued operations, and net income and weighted-average common shares outstanding for calculating basic earnings per share:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012     2011      2012     2011  

Basic:

         

Income from continuing operations

   $ 116,663      $ 74,817       $ 165,915      $ 115,516   

Income (loss) from discontinued operations, net of tax

     (9,637     6,293         (17,135     (8,173

Net income

     107,026        81,110         148,780        107,343   

Less: Distributed earnings to common shareholders

     40,744        38,810         81,308        77,461   

Less: Distributed earnings to participating securities

     19        19         34        35   
  

 

 

   

 

 

    

 

 

   

 

 

 

Undistributed earnings

     66,263        42,281         67,438        29,847   

Undistributed earnings allocated to common shareholders

     66,235        42,261         67,411        29,834   

Undistributed earnings allocated to participating securities

     28        20         27        13   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total income from continuing operations available to common shareholders, basic

   $ 116,616      $ 74,778       $ 165,854      $ 115,468   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total income available to common shareholders, basic

   $ 106,979      $ 81,071       $ 148,719      $ 107,295   
  

 

 

   

 

 

    

 

 

   

 

 

 

Weighted-average common shares outstanding, basic

     176,331        175,469         176,122        175,364   
  

 

 

   

 

 

    

 

 

   

 

 

 

Basic earnings per share: (a)

         

Income from continuing operations

   $ 0.66      $ 0.43       $ 0.94      $ 0.66   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from discontinued operations, net of tax

   $ (0.05   $ 0.04       $ (0.10   $ (0.05
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income

   $ 0.61      $ 0.46       $ 0.84      $ 0.61   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(a) Amounts may not sum due to rounding.

 

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Diluted earnings per common share is based on the weighted-average number of common shares outstanding, adjusted for the dilutive effect of common stock equivalents related to the restricted stock units, stock options, and employee stock purchase plan. The dilutive effect of the common stock equivalents is calculated using the treasury stock method and expected proceeds on vesting of the restricted stock units, exercise of the stock options and purchases under the employee stock purchase plan. The following is a reconciliation of the Company’s income from continuing operations, income (loss) from discontinued operations and net income and weighted-average common shares outstanding for calculating diluted earnings per share:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012     2011      2012     2011  

Diluted:

         

Total income from continuing operations available to common shareholders, basic

   $ 116,616      $ 74,778       $ 165,854      $ 115,468   

Income (loss) from discontinued operations, net of tax

     (9,637     6,293         (17,135     (8,173

Total income available to common shareholders, basic

     106,979        81,071         148,719        107,295   

Undistributed earnings allocated to participating securities

     28        20         27        13   

Total income from continuing operations available to common shareholders, diluted

   $ 116,644      $ 74,798       $ 165,881      $ 115,481   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total income available to common shareholders, diluted

   $ 107,007      $ 81,091       $ 148,746      $ 107,308   
  

 

 

   

 

 

    

 

 

   

 

 

 

Weighted-average common shares outstanding, basic

     176,331        175,469         176,122        175,364   

Stock-based compensation:

         

Restricted stock units

     573        475         550        443   

Stock options

     586        473         623        446   

Employee stock purchase plan

     1        2         1        2   
  

 

 

   

 

 

    

 

 

   

 

 

 

Weighted-average common shares outstanding, diluted

     177,491        176,419         177,296        176,255   
  

 

 

   

 

 

    

 

 

   

 

 

 

Diluted earnings per share: (a)

         

Income from continuing operations

   $ 0.66      $ 0.42       $ 0.94      $ 0.66   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from discontinued operations, net of tax

   $ (0.05   $ 0.04       $ (0.10   $ (0.05
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income

   $ 0.60      $ 0.46       $ 0.84      $ 0.61   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(a) Amounts may not sum due to rounding.

The following potentially dilutive common stock equivalents were not included in the earnings per share calculations because they were anti-dilutive:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

Stock options

     634         729         634         729   

Restricted stock units where certain performance conditions were not met

     63         139         63         140   

Note 13: Fair Value of Assets and Liabilities

Fair Value of Financial Instruments

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

Current assets and current liabilities: The carrying amounts reported in the accompanying Consolidated Balance Sheets for current assets and current liabilities, including revolving credit debt due to the short-term maturities and variable interest rates, approximate their fair values.

Preferred stock with mandatory redemption requirements and long-term debt: The fair values of preferred stock with mandatory redemption requirements and long-term debt are categorized within the fair value hierarchy based on the inputs that are used to value each instrument. The fair value of long-term debt classified as Level 1 is calculated using quoted prices in active markets. Level 2 instruments are valued using observable inputs and Level 3 instruments are valued using observable and unobservable inputs. The fair values of instruments classified as Level 2 and 3 are determined by a valuation model that is based on a conventional discounted cash flow methodology and utilizes assumptions of current market rates. The Company calculated a base yield curve using a risk-free rate (a U.S. Treasury securities yield curve) plus a credit spread that is based on the following two factors: an average of the Company’s own publicly-traded debt securities and the current market rates for U.S. Utility BBB+ debt securities. The Company used these yield curve assumptions to derive a base yield for the Level 2 and Level 3 securities. Additionally, the Company adjusted the base yield for specific features of the debt securities including call features, coupon tax treatment and collateral for the Level 3 instruments.

 

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The carrying amounts (including fair value adjustments previously recognized in acquisition purchase accounting) and fair values of the financial instruments are as follows:

 

            At Fair Value as of June 30, 2012  

Recurring Fair Value Measures

   Carrying
Amount
     Level 1      Level 2      Level 3      Total  

Preferred stocks with mandatory redemption requirements

   $ 20,925       $ 0       $ 0      $ 27,013       $ 27,013   

Long-term debt (excluding capital lease obligations)

     5,320,623         2,375,384        1,623,486         2,686,345         6,685,215   

 

As of December 31, 2011

   Carrying
Amount
     Fair Value  

Preferred stocks with mandatory redemption requirements

   $ 22,036       $ 26,458   

Long-term debt (excluding capital lease obligations)

     5,366,642         6,230,547   

Recurring Fair Value Measurements

The following table presents assets and liabilities measured and recorded at fair value on a recurring basis and their level within the fair value hierarchy as of June 30, 2012 and December 31, 2011, respectively:

 

     At Fair Value as of June 30, 2012  

Recurring Fair Value Measures

   Level 1      Level 2     Level 3      Total  

Assets:

          

Restricted funds

   $ 111,801         —          —         $ 111,801   

Rabbi trust investments

     —         $ 501        —           501   

Deposits

     1,866         —          —           1,866   

Mark-to-market derivative asset

     —           7,088        —           7,088   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total assets

   $ 113,667       $ 7,589        —         $ 121,256   
  

 

 

    

 

 

   

 

 

    

 

 

 

Liabilities:

          

Deferred compensation obligation

     —         $ 9,342        —         $ 9,342   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total liabilities

     —         $ 9,342        —         $ 9,342   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total net assets (liabilities)

   $ 113,667       $ (1,753     —         $ 111,914   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

     At Fair Value as of December 31, 2011  

Recurring Fair Value Measures

   Level 1      Level 2     Level 3      Total  

Assets:

          

Restricted funds

   $   57,941         —          —         $ 57,941   

Rabbi trust investments

     —         $ 518        —           518   

Deposits

     2,287         —          —           2,287   

Mark-to-market derivative asset

     —           5,824        —           5,824   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total assets

   $   60,228       $ 6,342        —         $ 66,570   
  

 

 

    

 

 

   

 

 

    

 

 

 

Liabilities:

          

Deferred compensation obligation

     —         $ 9,036        —         $ 9,036   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total liabilities

     —         $ 9,036        —         $ 9,036   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total net assets (liabilities)

   $   60,228       $ (2,694     —         $   57,534   
  

 

 

    

 

 

   

 

 

    

 

 

 

Restricted funds – The Company’s restricted funds primarily represent proceeds received from financings for the construction and capital improvement of facilities and from customers for future services under operations and maintenance projects. The proceeds of these financings are held in escrow until the designated expenditures are incurred. Restricted funds expected to be released within twelve months subsequent to the balance sheet date are classified as current.

Rabbi trust investments – The Company’s rabbi trust investments consist primarily of fixed income investments from which supplemental executive retirement plan benefits are paid. The Company includes these assets in other long-term assets.

Deposits – Deposits include escrow funds and certain other deposits held in trust. The Company includes cash deposits in other current assets.

 

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Deferred compensation obligations – The Company’s deferred compensation plans allow participants to defer certain cash compensation into notional investment accounts. The Company includes such plans in other long-term liabilities. The value of the Company’s deferred compensation obligations is based on the market value of the participants’ notional investment accounts. The notional investments are comprised primarily of mutual funds, which are based on observable market prices.

Mark-to-market derivative asset – The Company utilizes fixed-to-floating interest-rate swaps, typically designated as fair value hedges, to achieve a targeted level of variable-rate debt as a percentage of total debt. The Company uses a calculation of future cash inflows and estimated future outflows, which are discounted, to determine the current fair value. Additional inputs to the present value calculation include the contract terms, counterparty credit risk, interest rates and market volatility.

Note 14: Segment Information

The Company has two operating segments which are also the Company’s two reportable segments, referred to as Regulated Businesses and Market-Based Operations.

The following table includes the Company’s summarized segment information from continuing operations, except as noted below:

 

     As of or for the Three Months Ended
June 30, 2012
 
     Regulated
Businesses
     Market-Based
Operations
     Other     Consolidated  

Net operating revenues

   $ 667,601       $ 82,795       $ (4,789   $ 745,607   

Depreciation and amortization

     84,702         1,649         5,978        92,329   

Total operating expenses, net

     406,417         73,982         (5,424     474,975   

Income (loss) from continuing operations before income taxes

     204,874         9,738         (17,347     197,265   

Total assets

     12,434,806         281,572         1,696,383        14,412,761   

Assets of discontinued operations (included in total assets above)

     0         0         0        0   

Capital expenditures

     242,859         75         0        242,934   

Capital expenditures of discontinued operations (included in above)

     185         0         0        185   

 

     As of or for the Three Months Ended
June 30, 2011
 
     Regulated
Businesses
     Market-Based
Operations
     Other     Consolidated  

Net operating revenues

   $ 594,441       $ 82,424       $ (7,992   $ 668,873   

Depreciation and amortization

     79,797         1,727         5,818        87,342   

Total operating expenses, net

     400,719         75,753         (8,994     467,478   

Income (loss) from continuing operations before income taxes

     138,020         7,259         (19,195     126,084   

Total assets

     12,537,877         264,985         1,519,416        14,322,278   

Assets of discontinued operations (included in total assets above)

     906,547         7,188         4,428        918,163   

Capital expenditures

     214,045         1,336         0        215,381   

Capital expenditures of discontinued operations (included in above)

     5,139         26         0        5,165   

 

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     As of or for the Six Months Ended
June 30, 2012
 
     Regulated
Businesses
     Market-Based
Operations
     Other     Consolidated  

Net operating revenues

   $ 1,209,476       $ 163,376       $ (8,691   $ 1,364,161   

Depreciation and amortization

     169,490         3,330         11,613        184,433   

Total operating expenses, net

     801,059         144,747         (12,015     933,791   

Income (loss) from continuing operations before income taxes

     295,290         20,208         (33,588     281,910   

Total assets

     12,434,806         281,572         1,696,383        14,412,761   

Assets of discontinued operations (included in total assets above)

     0         0         0        0   

Capital expenditures

     476,057         243         0        476,300   

Capital expenditures of discontinued operations (included in above)

     2,884         0         0        2,884   

 

                                                           
     As of or for the Six Months Ended
June 30, 2011
 
     Regulated
Businesses
     Market-Based
Operations
     Other     Consolidated  

Net operating revenues

   $ 1,122,722       $ 157,806       $ (14,940   $ 1,265,588   

Depreciation and amortization

     158,377         3,496         12,347        174,220   

Total operating expenses, net

     795,066         144,027         (18,150     920,943   

Income (loss) from continuing operations before income taxes

     215,082         14,933         (35,287     194,728   

Total assets

     12,537,877         264,985         1,519,416        14,322,278   

Assets of discontinued operations (included in total assets above)

     906,547         7,188         4,428        918,163   

Capital expenditures

     390,017         1,775         0        391,792   

Capital expenditures of discontinued operations (included in above)

     11,019         84         0        11,103   

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

Certain matters within this Quarterly Report on Form 10-Q include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements included in this Form 10-Q, other than statements of historical fact, may constitute forward-looking statements. Forward-looking statements can be identified by the use of words such as “may,” “should,” “will,” “could,” “estimates,” “predicts,” “potential,” “continue,” “anticipates,” “believes,” “plans,” “expects,” “future” and “intends” and similar expressions. Forward-looking statements may involve known and unknown risks, uncertainties and other factors that may cause the actual results or performance to differ from those projected in the forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. Factors that could cause or contribute to differences in results and outcomes from those in our forward-looking statements include, without limitation, those items discussed in the “Risk Factors” section or other sections in the Company’s Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission (“SEC”), as well as in Item IA of Part II of this Quarterly Report. We undertake no obligation, other than as required by law, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

General

American Water Works Company, Inc. (herein referred to as “American Water” or the “Company”) is the largest investor-owned United States water and wastewater utility company, as measured both by operating revenue and population served. Our primary business involves the ownership of water and wastewater utilities that provide water and wastewater services to residential, commercial, industrial and other customers. Our Regulated Businesses that provide these services are generally subject to economic regulation by state regulatory agencies (“PUCs”) in the states in which they operate. We report the results of these businesses in our Regulated Businesses segment. We also provide services that are not subject to economic regulation by state regulatory agencies. We report the results of these businesses in our Market-Based Operations segment. For further description of our businesses see the “Business” section found in our Form 10-K for the year ended December 31, 2011 filed with the SEC.

You should read the following discussion in conjunction with our Consolidated Financial Statements and related Notes included elsewhere in this Quarterly Report on Form 10-Q and in our Form 10-K for the year ended December 31, 2011 filed with the SEC.

Overview

All financial information in this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), reflects only continuing operations. As previously disclosed in our Form 10-K for the year ended December 31, 2011, as part of our portfolio optimization initiative, we entered into agreements to sell our regulated subsidiaries in Arizona, New Mexico, Ohio and our regulated water and wastewater systems in Texas. The sale of the Texas subsidiary assets was completed in June 2011. In the first quarter of 2012, we completed the divestiture of the Arizona and New Mexico subsidiaries, and on May 1, 2012, we completed the divestiture of our Ohio subsidiary. Also, on December 31, 2011, we completed the sale of Applied Water Management, Inc. (“AWM”), which was part of our Contract Operations line of business within our Market-Based Operations segment. Therefore, the financial results of these entities have been presented as discontinued operations for all periods, unless otherwise noted. Additionally, during the fourth quarter of 2011, we discovered errors in our calculations of gains or losses on discontinued operations that originated in the first and second quarters of 2011. As a result, we recorded after-tax charges totaling $24.6 million, which included associated parent company goodwill, to reduce the net asset values of those businesses to their net realizable values. These charges were recognized within discontinued operations and net income and included in the operating results for the year ended December 31, 2011. The write-down included in the first and second quarters of 2011 totaled $21.1 million and $3.5 million, respectively, and are reflected, where necessary, in the amounts reported for the three and six months ended June 30, 2011.

Financial Results. For the three months ended June 30, 2012, we reported net income of $107.0 million, or diluted earnings per share (“EPS”) of $0.60 compared to $81.1 million, or diluted EPS of $0.46 for the comparable period in 2011. Income from continuing operations was $116.7 million for the second quarter of 2012 compared to $74.8 million in the second quarter of 2011. Diluted income from continuing operations per average common share was $0.66 for the second quarter of 2012 as compared to $0.42 for the second quarter of 2011.

For the six months ended June 30, 2012, our net income amounted to $148.8 million, or diluted earnings per share of $0.84 compared to $107.3 million, or diluted EPS of $0.61 for the comparable period in 2011. Income from continuing operations was $165.9 million for the six months ended June 30, 2012 compared to $115.5 million for the same period in 2011. Diluted income from continuing operations per average common share was $0.94 for the six months ended June 30, 2012 as compared to $0.66 for the first six months of 2011.

 

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The primary drivers contributing to these increases in net income from continuing operations for both the three and six months ended June 30, 2012 were increased revenues in our Regulated Businesses resulting from rate increases and higher demand, as well as slightly higher revenues in our Market-Based Operations segment. Partially offsetting these increases were higher depreciation and amortization expense and general taxes. For further details, see “Consolidated Results of Operations and Variances” and “Segment Results” below.

In 2012, our focus is on executing our portfolio optimization initiative, actively addressing regulatory lag and declining usage, continuing to make efficient use of capital and continuing to improve our regulated operation and maintenance (“O&M”) efficiency ratio. Also, in 2012, we look to grow our Market-Based Operations with a focus on the Homeowners Services Group and Military Contract Operations and to optimize our municipal contract operations business model to provide for value creation for both American Water and the municipality. The progress that we have made in the first six months of 2012 with respect to three of these objectives is described below. In regards to our other 2012 goals not explicitly outlined below, we continue to make progress.

Portfolio Optimization Initiative. We continue to execute our plan for optimizing our Regulated Businesses’ portfolio. In the first quarter of 2012, we completed the sale of our regulated operations in Arizona and New Mexico. On May 1, 2012, we completed the divestiture of our Ohio subsidiary, which served approximately 58,000 customers.

Also, on May 1, 2012, we completed our purchase of seven regulated water systems in New York, for $39.3 million in cash plus assumed liabilities of $67.6 million. This acquisition added approximately 50,000 customers to our New York regulated operations.

Addressing Regulatory Lag and Declining Usage. During the second quarter of 2012, we filed a general rate case in Tennessee requesting additional annualized revenues of approximately $10.6 million. Also, during the three months ended June 30, 2012, we were granted additional annualized revenues from general rate cases totaling $60.4 million.

On May 1, 2012, our New Jersey rate case, which we filed in the third quarter of 2011, was approved by the Board of Public Utilities. The new rates were effective May 1, 2012. On June 6, 2012, the Indiana Utility Regulatory Commission (“IURC”) issued an order adjusting rates on a statewide basis for Indiana American Water. The IURC order became effective June 15, 2012. On June 7, 2012, our California general rate case was approved by California’s Public Utilities Commission (“CPUC”), authorizing a total of approximately $28.5 million in additional annualized revenues for 2012. The increased revenue requirement was retroactively effective back to January 1, 2012.

Also, in April, 2012, additional annualized revenues of $1.7 million resulting from infrastructure charges for our Pennsylvania subsidiary became effective.

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

 

     Annualized Rate Increases Granted  
     For the three months ended      For the six months ended  
     June 30, 2012      June 30, 2012  
     (In millions)  

State

     

General Rate Cases:

     

New Jersey

   $ 30.0       $ 30.0   

Missouri

     —           24.0   

New York (a)

     —           5.6   

Iowa

     —           2.8   

Indiana

     1.9         1.9   

California

     28.5         28.5   

Other

     —           0.2   
  

 

 

    

 

 

 
Total General Rate Cases    $ 60.4       $ 93.0   
  

 

 

    

 

 

 

Infrastructure Charges

     

Pennsylvania

   $ 1.7       $ 1.7   

Other

   $ 0.3       $ 0.3   
  

 

 

    

 

 

 

Total Infrastructure charges

   $ 2.0       $ 2.0   
  

 

 

    

 

 

 

 

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a) Amount includes $3.0 million increase effective April 1, 2012. The remainder of the $5.6 million annualized revenue increase of $1.4 million and $1.2 million will become effective April 1, 2013 and April 1, 2014, respectively.

On July 1, 2012, additional annualized revenue of $3.0 million resulting from infrastructure charges in our Pennsylvania subsidiary became effective. Also on July 20, 2012, our New Jersey subsidiary filed a Foundational Filing for a Distribution System Improvement Charge.

On July 12, 2012, the CPUC approved California’s cost of capital application. This approval is retroactive to January 1, 2012 and is estimated to provide additional annualized revenues of $4.4 million. Also, on July 12, 2012, interim rates which would provide for an additional $6.0 million of annualized revenues, including $5.7 million of jurisdictional revenue under bond and subject to refund, were put into effect for our Virginia subsidiary. There is no assurance that the bonded amount, or any portion thereof, will be approved.

As of July 31, 2012, we are awaiting final orders in three states, requesting additional annualized revenues of $54.1 million. There is no assurance that all, or any portion of any requested increase, will be granted.

In regards to another regulatory matter, in June 2012, the CPUC approved our request to permanently remove the San Clemente Dam from the Carmel River on the Monterey Peninsula. The estimated project construction cost is $83 million, of which $49 million will be recovered from rate payers and $34 million will come from the State Coastal Conservancy. This decision also permitted California-American Water Company rate recovery of approximately $27 million in historical costs.

Continue Improvement in O&M Efficiency Ratio for our Regulated Businesses. Our O&M efficiency ratio (a non-GAAP measure) is calculated only on our Regulated operations and is defined as operation and maintenance expense divided by operating revenues where both operation and maintenance expense and operating revenues are adjusted for purchased water expense. Our operating efficiency ratio was 37.9% for the three months ended June 30, 2012 compared to 43.2% for the three months ended June 30, 2011. Our operating efficiency ratio was 41.2% for the six months ended June 30, 2012 compared to 45.5% for the same period in 2011.

The improvement in our O&M efficiency ratio was driven by our continued focus on operating expense control as well as an increase in revenue relating to rate cases and increased customer usage. We evaluate our operating performance using this measure because management believes it is one measure of the efficiency of our regulated operations. This information is intended to enhance an investor’s overall understanding of our operating performance. The O&M efficiency ratio is not a measure defined under GAAP and may not be comparable to other companies’ operating measures and should not be used in place of the GAAP information provided elsewhere in this report. The following table provides a reconciliation that compares operation and maintenance expense and operating revenues, as determined in accordance with GAAP, to Adjusted Regulated O&M expense and Adjusted Regulated Operating Revenues, and also shows our operating efficiency ratio for the three and six months ended June 30, 2012 as compared to the same periods in 2011:

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

 

     For the three months ended
June 30,
    For the six months ended
June 30,
 
     2012     2011     2012     2011  
     (In thousands)  

Total O&M expense

   $ 327,577      $ 327,157      $ 637,581      $ 637,978   

Less:

        

O&M expense – Market-Based Operations

     71,118        72,702        138,891        137,238   

O&M expense – Other

     (13,572     (16,928     (29,272     (35,596
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Regulated O&M expense

     270,031        271,383        527,962        536,336   

Less: Regulated purchased water

     27,597        25,565        50,007        46,380   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted Regulated O&M expense(a)

   $ 242,434      $ 245,818      $ 477,955      $ 489,956   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Operating Revenues

   $ 745,607      $ 668,873      $ 1,364,161      $ 1,265,588   

Less:

        

Operating revenues – Market-Based Operations

     82,795        82,424        163,376        157,806   

Operating revenues – Other

     (4,789     (7,992     (8,691     (14,940
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Regulated operating revenues

     667,601        594,441        1,209,476        1,122,722   

Less: Regulated purchased water expense*

     27,597        25,565        50,007        46,380   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted Regulated operating revenues(b)

   $ 640,004      $ 568,876      $ 1,159,469      $ 1,076,342   
  

 

 

   

 

 

   

 

 

   

 

 

 

Regulated O&M efficiency ratio(a)/(b)

     37.9     43.2     41.2     45.5

 

* Calculation assumes purchased water revenues approximate purchased water expenses.

 

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Other Matters

Business Transformation Project

On August 1, 2012, our new business systems associated with Phase I of our business transformation project went live. Phase I consisted of the roll-out of the Enterprise Resource Planning systems, which encompass applications that will handle human resources, finance, and supply chain/procurement management. Phase II consists of the roll-out of a new Enterprise Asset Management system, which will manage an asset’s lifecycle, and a Customer Information system, which contains all billing and data pertaining to American Water’s customers for our Regulated segment. Phase II is expected to be completed by December 31, 2013. As we make adjustments to our operations as a result of this project, we may incur incremental expenses prior to realizing the benefits of a more efficient workforce and operating structure. A project of this size will have an impact on our control environment. Although efforts have been made to minimize any adverse impact, we cannot assure that all such impacts have been mitigated. Through June 30, 2012, we have spent $211.5 million on the project with $71.7 million spent in 2012. Expenditures associated with the project are included in the estimated capital investment spending of $900 million for 2012 and $800 million to $1 billion in 2013.

Consolidated Results of Operations and Variances

 

     For the three months ended
June 30,
    For the six months ended
June 30,
 
     (In thousands, except per share data)  
(In thousands)    2012     2011     Favorable
(Unfavorable)
Change
    2012     2011     Favorable
(Unfavorable)
Change
 

Operating revenues

   $ 745,607      $ 668,873      $ 76,734      $ 1,364,161      $ 1,265,588      $ 98,573   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

            

Operation and maintenance

     327,577        327,157        (420     637,581        637,978        397   

Depreciation and amortization

     92,329        87,342        (4,987     184,433        174,220        (10,213

General taxes

     55,282        52,951        (2,331     112,403        108,449        (3,954

(Gain) loss on asset dispositions and purchases

     (213     28        241        (626     296        922   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses, net

     474,975        467,478        (7,497     933,791        920,943        (12,848
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     270,632        201,395        69,237        430,370        344,645        85,725   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expenses)

            

Interest, net

     (79,730     (78,469     (1,261     (159,384     (154,660     (4,724

Allowance for other funds used during construction

     5,076        2,535        2,541        9,438        5,363        4,075   

Allowance for borrowed funds used during construction

     2,313        1,198        1,115        4,394        2,402        1,992   

Amortization of debt expense

     (1,361     (1,255     (106     (2,627     (2,547     (80

Other, net

     335        680        (345     (281     (475     194   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expenses)

     (73,367     (75,311     1,944        (148,460     (149,917     1,457   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     197,265        126,084        71,181        281,910        194,728        87,182   

Provision for income taxes

     80,602        51,267        (29,335     115,995        79,212        (36,783
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     116,663        74,817        41,846        165,915        115,516        50,399   

Income (loss) from discontinued operations, net of tax

     (9,637     6,293        (15,930     (17,135     (8,173     (8,962
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 107,026      $ 81,110      $ 25,916      $ 148,780      $ 107,343      $ 41,437   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share:(a)

            

Income from continuing operations

   $ 0.66      $ 0.43        $ 0.94      $ 0.66     
  

 

 

   

 

 

     

 

 

   

 

 

   

Income from discontinued operations, net of tax

   $ (0.05   $ 0.04        $ (0.10   $ (0.05  
  

 

 

   

 

 

     

 

 

   

 

 

   

Net income

   $ 0.61      $ 0.46        $ 0.84      $ 0.61     
  

 

 

   

 

 

     

 

 

   

 

 

   

Diluted earnings per common share:(a)

            

Income from continuing operations

   $ 0.66      $ 0.42        $ 0.94      $ 0.66     
  

 

 

   

 

 

     

 

 

   

 

 

   

Income from discontinued operations, net of tax

   $ (0.05   $ 0.04        $ (0.10   $ (0.05  
  

 

 

   

 

 

     

 

 

   

 

 

   

Net income

   $ 0.60      $ 0.46        $ 0.84      $ 0.61     
  

 

 

   

 

 

     

 

 

   

 

 

   

Average common shares outstanding during the period:

            

Basic

     176,331        175,469          176,122        175,364     
  

 

 

   

 

 

     

 

 

   

 

 

   

Diluted

     177,491        176,419          177,296        176,255     
  

 

 

   

 

 

     

 

 

   

 

 

   

 

(a) Amounts may not sum due to rounding

 

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The following is a discussion of the consolidated results of operations for the three and six months ended June 30, 2012 compared to the three and six months ended June 30, 2011:

Three Months Ended June 30, 2012 Compared To Three Months Ended June 30, 2011

Operating revenues. Consolidated operating revenues for the three months ended June 30, 2012 increased $76.7 million, or 11.5%, compared to the same period in 2011 and is mainly attributable to a $73.2 million increase in our Regulated Businesses segment mainly as a result of rate increases as well as increased usage in the second quarter of 2012. For further information, see the respective “Operating Revenues” discussions within the “Segment Results.”

Operation and maintenance. Consolidated operation and maintenance expense for the three months ended June 30, 2012 increased by $0.4 million, or 0.1%, compared to the same period in 2011. For further information, see the respective “Operation and Maintenance” discussions within the “Segment Results.”

Depreciation and amortization. Depreciation and amortization expense increased by $5.0 million, or 5.7%, for the three months ended June 30, 2012 compared to the same period in the prior year as a result of additional utility plant placed in service.

General taxes. General taxes expense, which includes taxes for property, payroll, gross receipts, and other miscellaneous items, increased by $2.3 million, or 4.4%, for the three months ended June 30, 2012 compared to the three months ended June 30, 2011. This increase was principally due to higher property taxes of $1.8 million, primarily related to our recently acquired New York properties.

Other income (expenses). Other expenses decreased by $1.9 million, or 2.6%, for the three months ended June 30, 2012 compared to the same period in the prior year. This decrease is attributable to an increase in allowance for funds used during construction (“AFUDC”) of $3.7 million, which is mainly attributable to increased construction activity, including the replacement of a water treatment facility in our New Jersey regulated subsidiary. Partially offsetting this decrease was an increase in interest expense, net of interest income, of $1.3 million, or 1.6%, for the three months ended June 30, 2012 compared to the same period in the prior year, primarily attributable to higher interest expense associated with our interest rate swap and incremental interest expense on borrowings associated with certain restricted funds in 2012.

Provision for income taxes. Our consolidated provision for income taxes increased $29.3 million, or 57.2%, to $80.6 million for the three months ended June 30, 2012. The effective tax rates for the three months ended June 30, 2012 and 2011 were 40.9% and 40.7%, respectively.

Income (loss) from discontinued operations, net of tax. As noted above, the financial results of our regulated water and wastewater systems in Arizona, New Mexico, Texas and Ohio, as well as those of our AWM subsidiary within the Market-Based Operations segment, have been classified as discontinued operations for all periods presented. The increase in the loss from discontinued operations, net of tax is primarily attributable to the disposition of our Ohio subsidiary, which accounted for $5.2 million, and a $2.4 million pre-tax sales price adjustment in connection with the disposition of our Arizona and New Mexico subsidiaries. Additionally, the 2011 amount included net income associated with the discontinued operations for the period and a benefit of $3.2 million related to the cessation of depreciation for our Arizona, New Mexico, and Texas subsidiaries offset by $3.5 million after-tax write-down recorded in the second quarter of 2011 to reduce the net asset values of certain of the discontinued operations. Under GAAP, operations that are considered discontinued operations cease to depreciate their assets.

Six Months Ended June 30, 2012 Compared To Six Months Ended June 30, 2011

Operating revenues. Consolidated operating revenues for the six months ended June 30, 2012 increased $98.6 million, or 7.8%, compared to the same period in 2011. This change reflects an $86.8 million increase in our Regulated Businesses segment, which was mainly attributable to rate increases and usage, and a $5.6 million increase in our Market-Based Operations segment, which was due to contract growth and price increases in homeowner services, and incremental revenues associated with military construction and operations. For further information, see the “Operating Revenues” discussions within the “Segment Results.”

Operation and maintenance. Consolidated operation and maintenance expense for the six months ended June 30, 2012 decreased $0.4 million, or 0.1%, compared to the same period in 2011. For further information, see the “Operation and Maintenance” discussions within the “Segment Results.”

Depreciation and amortization. Depreciation and amortization expense increased by $10.2 million, or 5.9%, for the six months ended June 30, 2012 compared to the same period in the prior year as a result of additional utility plant placed in service.

General taxes. General taxes expense increased by $4.0 million, or 3.6%, for the six months ended June 30, 2012 compared to the six months ended June 30, 2011. This increase was principally due to higher property taxes of $2.2 million, which is primarily related to our recently acquired New York properties, as well as higher payroll and gross receipt taxes.

Other income (expenses). Other expenses decreased by $1.5 million, or 1.0%, for the six months ended June 30, 2012 compared to the same period in the prior year and is primarily attributable to an increase in AFUDC of $6.1 million related to increased construction activity,

 

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including the water treatment facility replacement project in our New Jersey subsidiary. Partially offsetting this decrease was an increase in interest expense, net of interest income, of $4.7 million, or 3.1%, for the six months ended June 30, 2012 compared to the same period in the prior year. This increase is mainly attributable to accelerated amortization recorded in 2011 of $3.1 million in unamortized debt discounts associated with debt that was redeemed during the first quarter of 2011, as well as higher interest expense associated with our interest rate swap and incremental interest expense on borrowings associated with certain restricted funds.

Provision for income taxes. Our consolidated provision for income taxes increased $36.8 million, or 46.4%, to $116.0 million for the six months ended June 30, 2012. The effective tax rates for the six months ended June 30, 2012 and 2011 were 41.1% and 40.7%, respectively.

Income (loss) from discontinued operations, net of tax. As noted above, the financial results of our regulated water and wastewater systems in Arizona, New Mexico, Texas and Ohio as well as those of our AWM subsidiary within the Market-Based Operations segment, have been classified as discontinued operations for all periods presented. The increase in loss from discontinued operations, net of tax is primarily related to the disposition of our Ohio subsidiary, $9.7 million in charges for income taxes resulting from the divestiture of our Arizona and New Mexico subsidiaries and the $2.4 million pre-tax sales price adjustment in connection with the disposition of our Arizona and New Mexico subsidiaries. Additionally, the 2011 amount included net income as a result of the operations of those subsidiaries and an after-tax benefit of $7.9 million related to the cessation of depreciation for our Arizona, New Mexico, and Texas subsidiaries. Under GAAP, operations that are considered discontinued operations cease to depreciate their assets. Partially offsetting the 2011 income (loss) from discontinued operations, net of tax amount was $24.6 million after-tax write-downs recorded in 2011 to reduce the net asset values of certain of our discontinued operations.

Segment Results

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

Regulated Segment

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

 

     For the three months ended
June 30,
    For the six months ended
June 30,
 
     2012      2011      Increase
(Decrease)
    2012      2011      Increase
(Decrease)
 
     (In thousands)         

Operating revenues

   $ 667,601       $ 594,441       $ 73,160      $ 1,209,476       $ 1,122,722       $ 86,754   

Operation and maintenance expense

     270,031         271,383         (1,352     527,962         536,336         (8,374

Operating expenses, net

     406,417         400,719         5,698        801,059         795,066         5,993   

Income from continuing operations before income taxes

     204,874         138,020         66,854        295,290         215,082         80,208   

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

Operating revenues increased by $73.2 million, or 12.3%, for the three months ended June 30, 2012 and $86.8 million, or 7.7%, for the six months ended June 30, 2012, respectively, as compared to the same periods in 2011. The increase in revenues was primarily due to rate increases obtained through rate authorizations for a number of our operating companies, higher demand, additional revenues associated with acquisitions and a retroactive adjustment in the second quarter of 2012 totaling $7.2 million resulting from the issuance of a final rate order in California.

The impact of rate increases on revenues was approximately $32.0 million and $52.2 million for the three and six months ending June 30, 2012, respectively. The increase in revenues associated with higher demand amounted to approximately $27 million and $21 million for the three and six months ended June 30, 2012, respectively, which is attributable to increased customer consumption in 2012 compared to 2011, which we believe is primarily attributable to the warmer/drier weather in the second quarter of 2012. Lastly, revenues were higher by $7.9 million and $8.5 million for the three and six months ended June 30, 2012, respectively, compared to the same period in 2011 as a result of acquisitions, with the most significant being our New York acquisition in the second quarter of 2012.

 

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

 

     For the three months ended June 30,  
     2012     2011     2012     2011  
     Operating Revenues     Billed Water Sales Volume  
     (Dollars in thousands)     (Gallons in millions)  

Customer Class

                    

Water service:

                    

Residential

   $ 383,879         57.5   $ 335,772         56.5     45,304         51.0     42,473         51.0

Commercial

     130,917         19.6     117,829         19.8     20,371         23.0     19,103         22.9

Industrial

     35,860         5.4     30,391         5.1     9,754         11.0     9,491         11.4

Public and other

     79,567         11.9     74,796         12.6     13,353         15.0     12,193         14.7

Other water revenues

     7,960         1.2     6,020         1.0     —           —          —           —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total water revenues

     638,183         95.6     564,808         95.0     88,782         100.0     83,260         100.0
            

 

 

    

 

 

   

 

 

    

 

 

 

Wastewater service

     19,669         2.9     19,411         3.3          

Other revenues

     9,749         1.5     10,222         1.7          
  

 

 

    

 

 

   

 

 

    

 

 

           
   $ 667,601         100.0   $ 594,441         100.0          
  

 

 

    

 

 

   

 

 

    

 

 

           

 

     For the six months ended June 30,  
     2012     2011     2012     2011  
     Operating Revenues     Billed Water Sales Volume  
     (Dollars in thousands)     (Gallons in millions)  

Customer Class

                    

Water service:

                    

Residential

   $ 689,776         57.0   $ 633,217         56.4     83,779         50.7     81,610         50.7

Commercial

     237,589         19.6     219,069         19.5     37,656         22.8     36,453         22.7

Industrial

     62,788         5.2     57,049         5.1     18,729         11.3     18,761         11.7

Public and other

     150,848         12.5     144,842         12.9     25,079         15.2     24,026         14.9

Other water revenues

     10,699         0.9     11,318         1.0     —           —          —           —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total water revenues

     1,151,700         95.2     1,065,495         94.9     165,243         100.0     160,850         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Wastewater service

     38,790         3.2     37,902         3.4          

Other revenues

     18,986         1.6     19,325         1.7          
  

 

 

    

 

 

   

 

 

    

 

 

           
   $ 1,209,476         100.0   $ 1,122,722         100.0          
  

 

 

    

 

 

   

 

 

    

 

 

           

Water Services – Water service operating revenues from residential customers for the three months ended June 30, 2012 increased by $48.1 million, or 14.3%, compared to the three months ended June 30, 2011. For the six months ended June 30, 2012 these revenues increased by $56.6 million, or 8.9%, over the same period in 2011. The increases are primarily due to rate increases as well as increased sales volumes. For the three months ended June 30, 2012, the volume of water sold to residential customers increased by 6.7% compared to the same period in 2011. For the six months ended June 30, 2012, the volume sold to these customers increased by 2.7% as compared to the same period in 2011. We believe this higher consumption for both the three and six month periods is driven by the warmer/drier weather in June 2012 in our eastern and midwestern operating states as compared to June 2011. Also contributing to the increased sales volumes was the additional consumption resulting from our New York acquisition.

Water service operating revenues from commercial water customers for the three months ended June 30, 2012 increased by $13.1 million, or 11.1%, compared to the same period in 2011. For the six months ended June 30, 2012, these revenues increased by $18.5 million, or 8.5%, to $237.6 million, compared to June 30, 2011. These increases were mainly due to rate increases as well as increased sales volume. The volume of water sold to commercial customers increased by 6.6% and 3.3% for the three and six months ended June 30, 2012, respectively, compared to the same periods in 2011.

Water service operating revenues from industrial customers, increased $5.5 million, or 18.0%, for the three months ended June 30, 2012 compared to those recorded for the same period of 2011, mainly due to rate increases and an increase in sales volume. For the three months ended June 30, 2012, the volume of water sold to industrial customers increased by 2.8% compared to the same

 

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period in 2011. For the six months ended June 30, 2012, water service operating revenues from industrial customers increased $5.7 million, or 10.1%, compared to the same period of 2011 and is primarily due to rate increases. The volume of water sold to industrial customers for the six months ended June 30, 2012 decreased 0.2% compared to the six months ended June 30, 2011.

Water service operating revenues from public and other customers, including municipal governments, other governmental entities and resale customers increased $4.8 million, or 6.4%, and $6.0 million, or 4.1%, for the three and six months ended June 30, 2012, respectively, mainly due to increased sale volumes.

Wastewater services – Our subsidiaries provide wastewater services in nine states. Revenues from these services increased by $0.3 million, or 1.3%, to $19.7 million for the three months ended June 30, 2012, compared to the same period of 2011. Revenues from these services for the six months ended June 30, 2012 increased by $0.9 million, or 2.3%, to $38.8 million, compared to the same period of 2011. The increases in both periods were primarily attributable to rate increases in a number of our operating companies.

Operation and maintenance. Operation and maintenance expense decreased $1.4 million, or 0.5%, for the three months ended June 30, 2012, compared to the three months ended June 30, 2011. Operation and maintenance expense decreased $8.4 million, or 1.6%, for the six months ended June 30, 2012, compared to the same period in the prior year. The following table provides information regarding operation and maintenance expense for the three and six months ended June 30, 2012 and 2011, by major expense category:

 

     For the three months ended June 30,     For the six months ended June 30,  
     2012      2011*      Increase
(Decrease)
    Percentage     2012      2011*      Increase
(Decrease)
    Percentage  
     (Dollars in thousands)  

Production costs

   $ 67,427       $ 65,711       $ 1,716        2.6   $ 125,887       $ 124,284       $ 1,603        1.3

Employee-related costs

     117,647         119,909         (2,262     (1.9 %)      233,008         242,491         (9,483     (3.9 %) 

Operating supplies and services

     46,294         47,475         (1,181     (2.5 %)      94,869         96,302         (1,433     (1.5 %) 

Maintenance materials and services

     15,922         16,187         (265     (1.6 %)      32,056         33,642         (1,586     (4.7 %) 

Customer billing and accounting

     10,337         12,761         (2,424     (19.0 %)      19,407         20,859         (1,452     (7.0 %) 

Other

     12,404         9,340         3,064        32.8     22,735         18,758         3,977        21.2
  

 

 

    

 

 

    

 

 

     

 

 

    

 

 

    

 

 

   

Total

   $ 270,031