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AWK > SEC Filings for AWK > Form 10-K on 27-Feb-2014All Recent SEC Filings

Show all filings for AMERICAN WATER WORKS COMPANY, INC.

Form 10-K for AMERICAN WATER WORKS COMPANY, INC.


27-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read together with the financial statements and the notes thereto included elsewhere in this Form 10-K. This discussion contains forward-looking statements that are based on management's current expectations, estimates and projections about our business, operations and financial performance. The cautionary statements made in this Form 10-K should be read as applying to all related forward-looking statements whenever they appear in this Form 10-K. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of a number of factors, including those we discuss under "Risk Factors" and elsewhere in this Form 10-K. You should read "Risk Factors" and "Forward-Looking Statements."

Executive Overview

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 approximately 6,600 employees provide drinking water, wastewater and other water related services to an estimated 14 million people in more than 40 states and in two Canadian provinces. 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 in the states in which they operate. The federal government and the states also regulate environmental, health and safety and water quality matters. Our Regulated Businesses provide services in 16 states and serve approximately 3.2 million customers based on the number of active service connections to our water and wastewater networks. 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. As noted under "Business Section," our financial condition and results of operations are influenced by a variety of industry-wide factors, including but not limited to (i) economic utility regulation; (ii) economic environment; (iii) the need for infrastructure investment; (iv) an overall trend of declining water usage per customer; (v) weather and seasonality; and
(vi) access to and quality of water supply.

In 2013, we continued the execution of our strategic goals. Our commitment to operational excellence led to continued improvement in our regulated operating efficiency, improved performance of our Market-Based Operations, and enabled us to provide increased value to our customers and investors. During the year, we focused on addressing regulatory lag, made more efficient use of capital and improved our regulated operation and maintenance ("O&M") efficiency ratio. Also, in 2013, we expanded both our Regulated Businesses and Market-Based Operations.


2013 Financial Results

For the year ended December 31, 2013, we continued to increase our net income, while continuing to make significant capital investment in our infrastructure and implementing operational efficiency improvements necessary to offset increases in depreciation and general taxes. Aided by rate increases, lower O&M and despite the unfavorable weather conditions in the second and third quarters of 2013, we generated $2,901.9 million in total operating revenue, and $369.3 million in net income, or diluted earnings per share ("EPS") of $2.06 compared to total operating revenue of $2,876.9 million, and $358.1 million in net income in 2012, or diluted EPS of $2.01. Net income from continuing operations was $369.3 million for the year ended December 31, 2013 compared to net income from continuing operations of $374.3 million for the year ended December 31, 2012. Net income and net income from continuing operations for 2013 included an after-tax charge of $24.8 million, or diluted EPS of $0.14 that was recorded in the fourth quarter to effect a tender offer that we announced in September of 2013. Diluted earnings from continuing operations per average common share was $2.06 for the year ended December 31, 2013 as compared to $2.11 for year ended December 31, 2012.


See "Consolidated Results of Operations and Variances" and "Segment Results" below for further detailed discussion of the consolidated results of operations, as well as our business segments. Also, note that all financial information in this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") reflects only continuing operations. In 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 our Texas subsidiary's assets was completed in June 2011, while the sales of our regulated subsidiaries in Arizona, New Mexico and Ohio were completed during 2012. Additionally, on December 13, 2011, we completed the sale of Applied Water Management, Inc. which was part of our Contract Operations line of business within our Market-Based segment. Therefore, the financial results of all of these entities have been presented as discontinued operations for all periods, unless otherwise noted. See Note 3 to Consolidated Financial Statements for further details on our discontinued operations.

Addressing Regulatory Lag

In 2013, we received authorizations for additional annualized revenues from general rate cases, totaling $41.4 million. During 2013, rate cases were approved for our Kentucky, West Virginia and Pennsylvania subsidiaries. Also, in 2013, we were granted $36.1 million in additional annualized revenues, assuming constant sales volume, from infrastructure charges in several of our states.

On April 30, 2013, we filed a general rate case in our Iowa subsidiary requesting additional annualized revenues of $6.4 million. On May 10, 2013, interim rates of $2.7 million in annualized revenues were approved and put into effect as interim rates under bond and subject to refund. On February 4, 2014, the Iowa Utilities Board (IUB) held a verbal decision meeting that would allow our Iowa subsidiary a permanent annual base rate increase of $3.9 million. The rate change would not become the final and binding decision of the IUB until its written decision is issued on or before February 28, 2014. The IUB does have the discretion to alter or reverse its position on the verbal decision in the final written order thus the permanent annual base rate increase of $3.9 million may be adjusted. If the verbal IUB decision is confirmed by final written order after taking into account the interim increase of $2.7 million such an award would result in an additional $1.2 million over revenue generated by interim rates.

On January 24, 2014, we filed a general rate case in Indiana requesting additional annualized revenues of $19.6 million. The rate case filing is using a fully forecasted test year for the first time.

On January 1, 2014, additional annualized revenues of $0.9 million, $10.1 million and $2.1 million resulting from infrastructure charges in our New York, New Jersey and Illinois subsidiaries became effective. On January 17, 2014 and January 31, 2013 we filed for additional annualized revenue of $0.7 million and $0.2 million, respectively, from infrastructure charges in our New York subsidiary. On February 25, 2014 our Missouri subsidiary filed for additional revenues from infrastructure charges in the amount of $3.1 million.

Other regulatory activities occurring in 2013 that allow us to address regulatory lag include our Tennessee subsidiary which on October 4, 2013 filed for approval of a Qualified Infrastructure Investment Program Rider, an Economic Development Investment Rider and a Safety and Environmental Compliance Rider totaling $0.5 million. Our Tennessee subsidiary is also filing for approval of a Production Costs and Other Pass-Throughs mechanism which cover over or under collection of authorized expenses for purchased power, chemicals, waste disposal, purchased water including wheeling charges, and the Tennessee Regulatory Authority inspection fee. This petition is pending regulatory approval. Our Missouri subsidiary proposed a rule addressing an Environmental Cost Adjustment Mechanism to pass through expenses and capital costs of mandated environmental compliance measures by a utility. The rulemaking was unanimously approved by the Public Service Commission on April 4, 2013. It was adopted on January 3, 2014 and will become effective 30 days after publication in the Code of State Regulations.

As of February 25, 2014, we are awaiting final orders in three states requesting additional annualized revenue of approximately $58.4 million.

Continuing Improvement in O&M Efficiency Ratio for our Regulated Businesses

We continued to improve on our O&M efficiency ratio during 2013. Our O&M efficiency ratio was 38.7% for the year ended December 31, 2013 compared to 40.1% and 42.4% for the years ended December 31, 2012 and 2011, respectively. Our O&M efficiency ratio (a non-GAAP measure) is defined as our regulated operation and maintenance expense divided by regulated operating revenues, where both O&M expense and operating revenues are adjusted to eliminate purchased water expense. We also exclude from the O&M expense the allocable portion of non-O&M support services cost, mainly depreciation and general taxes, that are reflected in the Regulated Businesses segment as O&M costs but for consolidated financial reporting purposes are categorized within other lines in the Statement of Operations. Management believes that this calculation better reflects the Regulated Businesses segment's O&M efficiency ratio. We evaluate our operating performance using this measure, as it is the primary measure of the efficiency of our regulated operations. This information is intended to enhance an investor's overall understanding of our operating performance. O&M efficiency ratio is not a measure defined under GAAP and may not be comparable to other companies' operating


measures or deemed more useful than the GAAP information provided elsewhere in this report. The following table provides a reconciliation between operation and maintenance expense and operating revenues, as determined in accordance with GAAP, and to those amounts utilized in the calculation of our O&M efficiency ratio for the years ended December 31, 2013, 2012 and 2011:

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



                                                 For the Years Ended December 31,
                                               2013            2012            2011
                                                          (In thousands)
 Total O&M expense                          $ 1,312,724     $ 1,350,040     $ 1,301,794
 Less:
 O&M expense-Market-Based Operations            264,253         276,809         278,375
 O&M expense-Other                              (56,973 )       (56,755 )       (69,192 )
 Total Regulated O&M expense                  1,105,444       1,129,986       1,092,611
 Less:
 Regulated purchased water expense              111,119         110,173          99,008
 Allocation of internal O&M costs                34,635          35,067          30,590
 Adjusted Regulated O&M expense (a)         $   959,690     $   984,746     $   963,013

 Total Operating Revenues                   $ 2,901,858     $ 2,876,889     $ 2,666,236
 Less:
 Operating revenues-Market-Based Operations     325,463         330,329         327,815
 Operating revenues-Other                       (17,523 )       (17,874 )       (30,470 )
 Total Regulated operating revenues           2,593,918       2,564,434       2,368,891
 Less: Regulated purchased water expense*       111,119         110,173          99,008
 Adjusted Regulated operating revenues (b)  $ 2,482,799     $ 2,454,261     $ 2,269,883
 Regulated O&M efficiency ratio (a)/(b)            38.7 %          40.1 %          42.4 %

* Note calculation assumes purchased water revenues approximate purchased water expenses.

Making Efficient Use of Capital

We invested approximately $950 million and $983 million in Company-funded capital improvements in 2013 and 2012, respectively. These capital investments are needed on an ongoing basis to comply with existing and new regulations, renew aging treatment and network assets, provide capacity for new growth and ensure system reliability, security and quality of service. The need for continuous investment presents a challenge due to the potential for regulatory lag, or the delay in recovering our operating expenses and earning an appropriate rate of return on our invested capital and obtaining a return of our invested capital. In conjunction with our capital investment program, management continued its focus on reducing regulatory lag during 2013.

In May 2013, we implemented the first wave of Phase II of our business transformation project in certain of our regulated subsidiaries. In October 2013, we implemented Phase II in our remaining regulated subsidiaries. Phase II consisted of the roll-out of a new Enterprise Asset Management system, which will manage an asset's lifecycle, and a Customer Information System, which will contain all billing and data pertaining to American Water's customers for our Regulated segment. With the final implementation of Phase II in October 2013, our business transformation project was substantially complete at December 31, 2013. Through December 31, 2013, we have spent $322.8 million, including AFUDC, on this business transformation project with $65.8 million of that amount spent in 2013.

Expanding Markets and Developing New Offerings

During 2013, our Regulated Business completed the purchase of ten water systems and five wastewater systems. These acquisitions added approximately 30,000 customers to our regulated operations. The largest of these acquisitions was the acquisition of Dale Service Corporation ("Dale") by our Virginia subsidiary on November 14, 2013. The service area of Dale overlapped with Virginia American Water's existing water service in Prince William County. With the Dale acquisition, we added approximately 20,100 wastewater customers to our existing customer base. Also, during 2013, our Market-Based Operations, through our Homeowner Services Group ("HOS") expanded its water and sewer line protection programs into 10 additional states and Washington, D.C.


In January, 2014, our Military Services Group, part of our Contract Operations Group within the Market-Based Operations was awarded a contract for ownership, operation and maintenance of the water and wastewater systems at Hill Air Force Base in Utah. According to the agreement the award is estimated at approximately $288 million over a 50-year period. We have begun the transition of the facility, which will be fully transitioned to us by September 1, 2014, when we will commence our operations of the facility under the contract. Also, in January 2014, HOS announced that it has expanded its water line and sewer line protection programs into three additional states, Maine, Minnesota and Oklahoma.

Other matters

West Virginia Event

On January 9, 2014, a chemical storage tank owned by Freedom Industries, Inc. leaked two substances used for processing coal, 4-methylcyclohexane methanol, or MCHM, and PPH, a mix of polyglycol ethers, into the Elk River near the West Virginia-American Water Company ("WVAWC") treatment plant in Charleston, West Virginia. After having been alerted to the leak by the DEP, WVAWC took immediate steps to gather more information about the chemical, augment its treatment as a precaution, and begin consultations with federal, state, and local public health officials. As soon as possible after it was determined that the augmented treatment process would not fully remove the chemical, a joint decision was reached in consultation with the West Virginia Bureau for Public Health to issue a "Do Not Use" order to approximately 300,000 people in parts of nine West Virginia counties. The order addressed the use of water for drinking, cooking, washing and bathing, but did not affect continued use of water for sanitation and fire protection. Over the next several days, WVAWC and an interagency team of state and federal officials engaged in extensive testing to determine if levels of MCHM were below one part per million (1 ppm), a level that the U.S. Centers for Disease Control and Prevention (CDC) and U.S. Environmental Protection Agency indicated would be protective of public health. Based on the results of continued testing, the Do Not Use order was lifted in stages, beginning on January 13, 2014. By January 18th, none of WVAWC's customers were subject to the Do Not Use order, although CDC guidance suggesting that pregnant women avoid consuming the water until the chemicals are at non-detectable levels remained in place. In addition, based on re-analysis of previously saved samples, PPH was no longer detected at any sampling locations as of January 18, 2014. On February 21, 2014, WVAWC announced that all points of testing throughout its water distribution system indicated that levels of MCHM are below 10 parts per billion (10 ppb). The interagency team established 10 ppb as the "non-detect" level of MCHM in the water distribution system based on the measurement capabilities of the multiple laboratories used. WVAWC is continuing sampling and testing in an effort to pinpoint its flushing activities and address odor issues.

To date, an aggregate of 50 lawsuits have been filed against WVAWC with respect to this matter in the United States District Court for the Southern District of West Virginia, and West Virginia Circuit Courts in Kanawha, Boone, and Putman counties, many of which also name Freedom Industries (which is now in bankruptcy) and a few also name the Company or other Company affiliates. The complaints generally seek class action status; raise claims based on a variety of tort, statutory and contract theories; and seek a combination of compensatory damages, punitive damages, medical monitoring, and other equitable relief. Additionally, investigations with respect to the matter have been initiated by the Chemical Safety Board, the U.S. Attorney's Office for the Southern District of West Virginia, the West Virginia Attorney General, and other governmental entities.

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

National Benefits Agreement

In September 2010, we declared "impasse" in negotiations of our national benefits agreement with most of the labor unions representing employees in our Regulated Businesses. The prior agreement expired on July 31, 2010; however, negotiations did not produce a new agreement. We implemented our "last, best and final" offer on January 1, 2011 in order to provide health care coverage for our employees in accordance with the terms of the offer. The unions have challenged our right to implement our last, best, and final offer. In this regard, following the filing by the Utility Workers Union of America of an unfair labor practice charge, the NLRB issued a complaint against us in January 2012, claiming that we implemented the last, best and final offer without providing sufficient notice of the existence of a dispute with the Federal Mediation and Conciliation Service, a state mediation agency, and several state departments of labor. We have asserted that we did, in fact, provide sufficient notice.

On October 16, 2012, the NLRB Administrative Law Judge hearing the matter ruled that, although we did provide sufficient notification to the Federal Mediation and Conciliation Service, we did not provide notice to state agencies, in violation of the National Labor Relations Act. The Administrative Law Judge ordered, among other things, that we cease and desist from implementing the terms of our last, best and final offer and make whole all affected employees for losses suffered as a result of our implementation of


our last, best and final offer. The "make whole" order, if upheld on appeal, would require us to provide back-pay plus interest, from January 1, 2011 through the date of the final determination by the NLRB. Based on current estimates and assumptions, we estimate the cash impact could be in the range of $3.5 to $4.5 million per year, with the total impact dependent on the length of time the issue remains unresolved. On November 2012, we filed an exception to the decision of the Administrative Law Judge in order to obtain a review by the full NLRB. We expect to hear from the NLRB during 2014.

2014 and Beyond

Our strategy for the future will continue to focus on customer satisfaction and service, expansion through targeted growth, environmental sustainability, and constructive regulatory and public policy. We will also continue to modernize our infrastructure and to focus on operational efficiencies, while bolstering a culture of continuous improvement.

For 2014 and beyond, we expect our earnings growth drivers to be 1) our Regulated Business investment; 2) growth from acquisitions; 3) growth in Market-Based businesses; and lastly 4) potential growth opportunities in serving the shale industry. Also, in 2014, we anticipate savings from corporate expense reductions attributable to lower SAP-related implementation costs, lower pension costs, further reduced headcount and lower interest expense resulting from our 2013 debt refinancings.

In 2014, we will continue to concentrate on our customers by achieving established customer satisfaction and service quality targets. In regards to environmental sustainability, we are committed to maximizing our protection of the environment, reducing our carbon and waste footprints and water lost through leakage. Specific goals established for 2014 are to:

1) Optimize capital spend

2) Continue to promote constructive regulatory frameworks

3) Improve our O&M efficiency ratio

4) Execute our regulated acquisition strategy; and

5) Continue to grow our Market-Based Operations.

We will optimize our capital spend by not only focusing on how much we spend but the efficiency with which we spend it. We estimate our capital expenditure plan for 2014 through 2018 will be approximately $5.8 billion. Of the $5.8 billion, $5.1 million is expected to be utilized to upgrade our infrastructure and systems. In addition to these capital expenditures, we are also estimating additional capital investment over the five-year period for acquisitions and strategic capital of approximately $400 million and $300 million, respectively. Strategic investments could include opportunities in the unregulated shale arena or a major concession. Our total capital plan for 2014 is estimated to be approximately $1.1 billion with approximately $900 million allocated to upgrading our infrastructure and systems, $100 million for acquisitions and $100 million for strategic investment purposes.

We will engage in appropriate legislative and regulatory policy changes by actively addressing regulatory lag that impacts return on our investments and promoting constructive regulatory frameworks. We expect to resolve three rate proceedings during 2014 and plan to file up to five general rate cases, including one which was already filed in January 2014. Additionally, we will file for infrastructure surcharges and continue to pursue other mechanisms, either as part of our general rate case filings or in separate filings, which will provide opportunities to expedite the return of capital outside of the general rate case and continue to close the gap between our allowed and our earned regulated return.

We also expect to continue to improve our regulated O&M efficiency ratio. We expect to achieve an O&M efficiency ratio equal to or below 35% by 2018. A significant component in both the optimization of capital spend and O&M efficiency objectives is to optimize our supply chain process to provide more value for each dollar of capital and O&M spent.

Lastly, we will look to execute our regulated acquisition strategy and continue to grow our Market-Based Operations, in particular HOS and our military services contracts, while evaluating potential opportunities to assist the shale industry in the delivery of water to assist with their processes. We will expand our Regulated Business segment through focused acquisitions and/or organic growth, while expanding in our Market-Based segment from new core growth, expanded markets and new offerings. In regards to our Market-Based Operations, as noted above, in early January 2014, we added the Hill Air Force Base to our military contracts and have expanded our HOS service line protection programs into three additional states. We are committed to operating our business responsibly and managing our operating and capital costs in a manner that serves our customers and produces value for our shareholders. We are committed to an ongoing strategy that leverages processes and technology innovation to make ourselves more effective and efficient.


Consolidated Results of Operations

The following table sets forth our consolidated statement of operations data for the years ended December 31, 2013, 2012 and 2011:

                                                               Years ended December 31,
                                                         2013            2012            2011
Operating revenues                                    $ 2,901,858     $ 2,876,889     $ 2,666,236
Operating expenses
Operation and maintenance                               1,312,724       1,350,040       1,301,794
Depreciation and amortization                             407,718         381,503         351,821
General taxes                                             234,642         221,212         210,478
(Gain) loss on asset dispositions and purchases               925            (839 )          (993 )
Total operating expenses, net                           1,956,009       1,951,916       1,863,100
Operating income                                          945,849         924,973         803,136
Other income (expenses)
Interest, net                                            (308,164 )      (310,794 )      (312,415 )
Loss on extinguishment of debt                            (40,583 )             -               -
Allowance for other funds used during construction         12,639          15,592          13,131
Allowance for borrowed funds used during construction       6,377           7,771           5,923
. . .
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