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Section 1: 10-Q (10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 

FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
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.    ☒  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).    ☒  Yes    ☐  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
 
(Do not check if a smaller reporting company)
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.).    ☐  Yes    ☒  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 as of April 26, 2018
Common Stock, $0.01 par value per share
 
178,047,882 shares
(excludes 4,683,156 treasury shares as of April 26, 2018)




TABLE OF CONTENTS

 
 
Page
 
 
Item 1.
Item 2.
Item 3.
Item 4.
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.


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FORWARD-LOOKING STATEMENTS
We have made statements in Part I, Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations and in other sections of this Quarterly Report on Form 10-Q (“Form 10-Q”), that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995. In some cases, these forward-looking statements can be identified by words with prospective meanings such as “intend,” “plan,” “estimate,” “believe,” “anticipate,” “expect,” “predict,” “project,” “propose,” “assume,” “forecast,” “likely,” “uncertain,” “outlook,” “future,” “pending,” “goal,” “objective,” “potential,” “continue,” “seek to,” “may,” “can,” “should,” “will” and “could” or the negative of such terms or other variations or similar expressions. Forward-looking statements may relate to, among other things, our future financial performance, including our operation and maintenance (“O&M”) efficiency ratio, cash flows, our growth and portfolio optimization strategies, our projected capital expenditures and related funding requirements, our ability to repay debt, our projected strategy to finance current operations and growth initiatives, the impact of legal proceedings and potential fines and penalties, business process and technology improvement initiatives, trends in our industry, regulatory, legislative, tax policy or legal developments or rate adjustments, including rate case filings, filings for infrastructure surcharges and filings to address regulatory lag, and impacts that the Tax Cuts and Jobs Act (the “TCJA”) may have on us and our business, results of operations, cash flows and liquidity.
Forward-looking statements are predictions based on our current expectations and assumptions regarding future events. They are not guarantees or assurances of any outcomes, financial results or levels of activity, performance or achievements, and you are cautioned not to place undue reliance upon them. These forward-looking statements are subject to a number of estimates and assumptions, and known and unknown risks, uncertainties and other factors. Our actual results may vary materially from those discussed in the forward-looking statements included herein as a result of the following important factors:
the decisions of governmental and regulatory bodies, including decisions to raise or lower customer rates;
the timeliness and outcome of regulatory commissions’ actions concerning rates, capital structure, authorized return on equity, capital investment, system acquisitions, taxes, permitting and other decisions;
changes in customer demand for, and patterns of use of, water, such as may result from conservation efforts;
limitations on the availability of our water supplies or sources of water, or restrictions on our use thereof, resulting from allocation rights, governmental or regulatory requirements and restrictions, drought, overuse or other factors;
changes in laws, governmental regulations and policies, including with respect to environmental, health and safety, water quality and emerging contaminants, public utility and tax regulations and policies, and impacts resulting from U.S., state and local elections;
weather conditions and events, climate variability patterns, and natural disasters, including drought or abnormally high rainfall, prolonged and abnormal ice or freezing conditions, strong winds, coastal and intercoastal flooding, earthquakes, landslides, hurricanes, tornadoes, wildfires, electrical storms and solar flares;
the outcome of litigation and similar governmental proceedings, investigations or actions, including matters related to the Freedom Industries chemical spill in West Virginia and the preliminarily approved global class action settlement agreement related to this chemical spill;
our ability to appropriately maintain current infrastructure, including our operational and information technology (“IT”) systems, and manage the expansion of our business;
exposure or infiltration of our critical infrastructure, operational technology and IT systems, including the disclosure of sensitive or confidential information contained therein, through physical or cyber attacks or other means;
our ability to obtain permits and other approvals for projects;
changes in our capital requirements;
our ability to control operating expenses and to achieve efficiencies in our operations;
the intentional or unintentional actions of a third party, including contamination of our water supplies or water provided to our customers;
our ability to obtain adequate and cost-effective supplies of chemicals, electricity, fuel, water and other raw materials that are needed for our operations;
our ability to successfully meet growth projections for our business and capitalize on growth opportunities, including our ability to, among other things, acquire and integrate water and wastewater systems into our regulated operations, and enter into contracts and other agreements with, or otherwise obtain, new customers in our market-based businesses;

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risks and uncertainties associated with contracting with the U.S. government, including ongoing compliance with applicable government procurement and security regulations;
cost overruns relating to improvements in or the expansion of our operations;
our ability to maintain safe work sites;
our exposure to liabilities related to environmental laws and similar matters resulting from, among other things, water and wastewater service provided to customers, including, for example, our water service and management solutions that are focused on customers in the shale natural gas exploration and production market;
changes in general economic, political, business and financial market conditions;
access to sufficient capital on satisfactory terms and when and as needed to support operations and capital expenditures;
fluctuations in interest rates;
restrictive covenants in or changes to the credit ratings on us or our current or future debt that could increase our financing costs or funding requirements or affect our ability to borrow, make payments on debt or pay dividends;
fluctuations in the value of benefit plan assets and liabilities that could increase our cost and funding requirements;
changes in federal or state general, income and other tax laws, including any further rules, regulations, interpretations and guidance by the U.S. Department of the Treasury and state or local taxing authorities related to the enactment of the TCJA, the availability of tax credits and tax abatement programs, and our ability to utilize our U.S. federal and state income tax net operating loss (“NOL”) carryforwards;
migration of customers into or out of our service territories;
the use by municipalities of the power of eminent domain or other authority to condemn our systems, or the assertion by private landowners of similar rights against us;
difficulty or inability to obtain insurance, our inability to obtain insurance at acceptable rates and on acceptable terms and conditions, or our inability to obtain reimbursement under existing insurance programs for any losses sustained;
the incurrence of impairment charges related to our goodwill or other assets;
labor actions, including work stoppages and strikes;
the ability to retain and attract qualified employees;
civil disturbances or terrorist threats or acts, or public apprehension about future disturbances or terrorist threats or acts;
the impact of new, and changes to existing, accounting standards;
obtaining regulatory consents and approvals required to complete, and satisfying other conditions to the closing of, the acquisition (the “Acquisition”) of all of the capital stock of Nicor Energy Services Company, doing business as Pivotal Home Solutions (“Pivotal”);
the timing of the closing of the Acquisition;
our ability to finance the purchase price of the Acquisition;
our ability to realize benefits and synergies following the completion of the Acquisition;
unexpected costs, liabilities or delays associated with the Acquisition or the integration of the business represented thereby;
the timing and method of settlement of forward sale agreements we entered into to finance a portion of the purchase price of the Acquisition; and
the amount and intended use of proceeds that may be received from the settlement of the forward sale agreements.
These forward-looking statements are qualified by, and should be read together with, the risk factors and other statements contained in our Annual Report on Form 10-K for the year ended December 31, 2017 (“Form 10-K”), and in this Form 10-Q, and you should refer to such risks, uncertainties and risk factors in evaluating such forward-looking statements. Any forward-looking statements we make speak only as of the date this Form 10-Q was filed with the U.S. Securities and Exchange Commission (“SEC”). Except as required by the federal securities laws, we do not have any obligation, and we specifically disclaim any undertaking or intention, to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or otherwise. New factors emerge from time to time, and it is not possible for us to predict all such factors. Furthermore, it may not be possible to assess the impact of any such factor on our businesses, either viewed independently or together, or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. The foregoing factors should not be construed as exhaustive.

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PART I. FINANCIAL INFORMATION
ITEM 1.    CONSOLIDATED FINANCIAL STATEMENTS
American Water Works Company, Inc. and Subsidiary Companies
Consolidated Balance Sheets (Unaudited)
(In millions, except share and per share data) 
 
March 31, 2018
 
December 31, 2017
ASSETS
Property, plant and equipment
$
21,995

 
$
21,716

Accumulated depreciation
(5,518
)
 
(5,470
)
Property, plant and equipment, net
16,477

 
16,246

Current assets:
 

 
 

Cash and cash equivalents
55

 
55

Restricted funds
26

 
27

Accounts receivable, net
273

 
272

Unbilled revenues
188

 
212

Materials and supplies
42

 
41

Other
145

 
113

Total current assets
729

 
720

Regulatory and other long-term assets:
 

 
 

Regulatory assets
1,062

 
1,061

Goodwill
1,379

 
1,379

Other
81

 
76

Total regulatory and other long-term assets
2,522

 
2,516

Total assets
$
19,728

 
$
19,482

The accompanying notes are an integral part of these Consolidated Financial Statements.

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American Water Works Company, Inc. and Subsidiary Companies
Consolidated Balance Sheets (Unaudited)
(In millions, except share and per share data) 
 
March 31, 2018
 
December 31, 2017
CAPITALIZATION AND LIABILITIES
Capitalization:
 
 
 
Common stock ($0.01 par value, 500,000,000 shares authorized, 182,723,455 and 182,508,564 shares issued, respectively)
$
2

 
$
2

Paid-in-capital
6,438

 
6,432

Accumulated deficit
(617
)
 
(723
)
Accumulated other comprehensive loss
(75
)
 
(79
)
Treasury stock, at cost (4,683,156 and 4,064,010 shares, respectively)
(297
)
 
(247
)
Total common stockholders' equity
5,451

 
5,385

Long-term debt
6,396

 
6,490

Redeemable preferred stock at redemption value
7

 
8

Total long-term debt
6,403

 
6,498

Total capitalization
11,854

 
11,883

Current liabilities:
 

 
 

Short-term debt
1,183

 
905

Current portion of long-term debt
421

 
322

Accounts payable
133

 
195

Accrued liabilities
495

 
630

Taxes accrued
64

 
33

Interest accrued
84

 
73

Other
159

 
167

Total current liabilities
2,539

 
2,325

Regulatory and other long-term liabilities:
 

 
 

Advances for construction
265

 
271

Deferred income taxes, net
1,585

 
1,551

Deferred investment tax credits
22

 
22

Regulatory liabilities
1,673

 
1,664

Accrued pension expense
390

 
384

Accrued post-retirement benefit expense
39

 
40

Other
74

 
66

Total regulatory and other long-term liabilities
4,048

 
3,998

Contributions in aid of construction
1,287

 
1,276

Commitments and contingencies (See Note 11)


 


Total capitalization and liabilities
$
19,728

 
$
19,482

The accompanying notes are an integral part of these Consolidated Financial Statements.


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American Water Works Company, Inc. and Subsidiary Companies
Consolidated Statements of Operations (Unaudited)
(In millions, except per share data)
 
For the Three Months Ended March 31,
 
2018
 
2017
Operating revenues
$
761

 
$
756

Operating expenses:
 
 
 
Operation and maintenance
347

 
334

Depreciation and amortization
129

 
124

General taxes
70

 
68

Gain on asset dispositions and purchases
(2
)
 

Total operating expenses, net
544

 
526

Operating income
217

 
230

Other income (expense):
 
 
 
Interest, net
(84
)
 
(85
)
Non-operating benefit costs, net
3

 
(3
)
Other, net
4

 
3

Total other income (expense)
(77
)
 
(85
)
Income before income taxes
140

 
145

Provision for income taxes
34

 
52

Net income attributable to common stockholders
$
106

 
$
93

 
 
 
 
Basic earnings per share:
 
 
 
Net income attributable to common stockholders
$
0.60

 
$
0.52

Diluted earnings per share:
 
 
 
Net income attributable to common stockholders
$
0.59

 
$
0.52

Weighted-average common shares outstanding:
 
 
 
Basic
178

 
178

Diluted
179

 
179

Dividends declared per common share
$

 
$

The accompanying notes are an integral part of these Consolidated Financial Statements.


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American Water Works Company, Inc. and Subsidiary Companies
Consolidated Statements of Comprehensive Income (Unaudited)
(In millions)
 
For the Three Months Ended March 31,
 
2018
 
2017
Net income attributable to common stockholders
$
106

 
$
93

Other comprehensive income (loss), net of tax:
 
 
 
Pension amortized to periodic benefit cost:
 
 
 
Actuarial (gain) loss, net of tax of ($1) and $1 for the three months ended March 31, 2018 and 2017, respectively
(2
)
 
2

Foreign currency translation adjustment

 
(1
)
Unrealized gain on cash flow hedges, net of tax of $2 for the three months ended March 31, 2018 and 2017
6

 
3

Net other comprehensive income
4

 
4

Comprehensive income attributable to common stockholders
$
110

 
$
97

The accompanying notes are an integral part of these Consolidated Financial Statements.

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American Water Works Company, Inc. and Subsidiary Companies
Consolidated Statements of Cash Flows (Unaudited)
(In millions)
 
For the Three Months Ended March 31,
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net income
$
106

 
$
93

Adjustments to reconcile to net cash flows provided by operating activities:
 
 
 
Depreciation and amortization
129

 
124

Deferred income taxes and amortization of investment tax credits
33

 
64

Provision for losses on accounts receivable
3

 
4

Gain on asset dispositions and purchases
(2
)
 

Pension and non-pension post-retirement benefits
8

 
15

Other non-cash, net
(10
)
 
(18
)
Changes in assets and liabilities:
 
 
 
Receivables and unbilled revenues
20

 
51

Pension and non-pension post-retirement benefit contributions

 
(11
)
Accounts payable and accrued liabilities
(73
)
 
(72
)
Other assets and liabilities, net
5

 
27

Net cash provided by operating activities
219

 
277

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Capital expenditures
(364
)
 
(270
)
Acquisitions, net of cash acquired
(8
)
 
(2
)
Proceeds from sale of assets and securities
6

 

Removal costs from property, plant and equipment retirements, net
(20
)
 
(13
)
Net cash used in investing activities
(386
)
 
(285
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Proceeds from long-term debt
10

 

Repayments of long-term debt
(6
)
 
(4
)
Net short-term borrowings with maturities less than three months
278

 
131

Proceeds from issuances of employee stock plans and direct stock purchase plan
4

 
10

Advances and contributions for construction, net of refunds of $4 for the three months ended March 31, 2018 and 2017, respectively
4

 
7

Dividends paid
(74
)
 
(67
)
Anti-dilutive share repurchases
(45
)
 
(54
)
Taxes paid related to employee stock plans
(5
)
 
(9
)
Net cash provided by financing activities
166

 
14

Net (decrease) increase in cash and cash equivalents and restricted funds
(1
)
 
6

Cash and cash equivalents and restricted funds at beginning of period
83

 
99

Cash and cash equivalents and restricted funds at end of period
$
82

 
$
105

Non-cash investing activity:
 
 
 
Capital expenditures acquired on account but unpaid as of end of period
$
175

 
$
142

 
The accompanying notes are an integral part of these Consolidated Financial Statements.


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American Water Works Company, Inc. and Subsidiary Companies
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
(In millions)
 
Common Stock
 
Paid-in-Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Loss
 
Treasury Stock
 
Total Stockholders' Equity
 
Shares
 
Par Value
 
 
 
 
Shares
 
At Cost
 
Balance as of December 31, 2017
182.5

 
$
2

 
$
6,432

 
$
(723
)
 
$
(79
)
 
(4.1
)
 
$
(247
)
 
$
5,385

Net income attributable to common stockholders

 

 

 
106

 

 

 

 
106

Direct stock reinvestment and purchase plan

 

 
1

 

 

 

 

 
1

Employee stock purchase plan

 

 
1

 

 

 

 

 
1

Stock-based compensation activity
0.2

 

 
4

 

 

 
(0.1
)
 
(5
)
 
(1
)
Repurchases of common stock

 

 

 

 

 
(0.5
)
 
(45
)
 
(45
)
Net other comprehensive income

 

 

 

 
4

 

 

 
4

Balance as of March 31, 2018
182.7

 
$
2

 
$
6,438

 
$
(617
)
 
$
(75
)
 
(4.7
)
 
$
(297
)
 
$
5,451

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
Paid-in-Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Loss
 
Treasury Stock
 
Total Stockholders' Equity
 
Shares
 
Par Value
 
 
 
 
Shares
 
At Cost
 
Balance as of December 31, 2016
181.8

 
$
2

 
$
6,388

 
$
(873
)
 
$
(86
)
 
(3.7
)
 
$
(213
)
 
$
5,218

Cumulative effect of change in accounting principle

 

 

 
21

 

 

 

 
21

Net income attributable to common stockholders

 

 

 
93

 

 

 

 
93

Direct stock reinvestment and purchase plan

 

 
3

 

 

 

 

 
3

Employee stock purchase plan

 

 
2

 

 

 

 

 
2

Stock-based compensation activity
0.4

 

 
7

 

 

 
(0.1
)
 
(7
)
 

Repurchases of common stock

 

 

 

 

 
(0.7
)
 
(54
)
 
(54
)
Net other comprehensive income

 

 

 

 
4

 

 

 
4

Balance as of March 31, 2017
182.2

 
$
2

 
$
6,400

 
$
(759
)
 
$
(82
)
 
(4.5
)
 
$
(274
)
 
$
5,287

The accompanying notes are an integral part of these Consolidated Financial Statements.

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American Water Works Company, Inc. and Subsidiary Companies
Notes to Consolidated Financial Statements (Unaudited)
(Unless otherwise noted, in millions, except per share data)
Note 1: Basis of Presentation
The unaudited Consolidated Financial Statements provided in this report include the accounts of American Water Works Company, Inc. and all of its subsidiaries (collectively, “American Water” or the “Company”), in which a controlling interest is maintained after the elimination of intercompany accounts and transactions. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting, and with the rules and regulations for reporting on Quarterly Reports on Form 10-Q (“Form 10-Q”). Accordingly, they do not contain certain information and disclosures required by GAAP for comprehensive financial statements. In the opinion of management, all adjustments necessary for a fair statement of the financial position as of March 31, 2018, and results of operations and cash flows for all periods presented have been made. All adjustments are of a normal, recurring nature, except as otherwise disclosed.
The unaudited Consolidated Financial Statements and notes included in this report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 (“Form 10-K”), which provides a more complete discussion of the Company’s accounting policies, financial position, operating results and other matters. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the year, primarily due to the seasonality of the Company’s operations.
Note 2: Significant Accounting Policies
New Accounting Standards
The Company adopted the following accounting standards as of January 1, 2018:
Standard
 
Description
 
Date of
Adoption
 
Application
 
Effect on the Consolidated Financial Statements
Revenue from Contracts with Customers
 
Changes the criteria for recognizing revenue from a contract with a customer. Replaces existing guidance on revenue recognition, including most industry specific guidance. The objective is to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability within industries, across industries and across capital markets. The underlying principle is that an entity will recognize revenue to depict the transfer of goods and services to customers at an amount the entity expects to be entitled to in exchange for those goods or services. The guidance also requires a number of disclosures regarding the nature, amount, timing and uncertainty of revenue and the related cash flows.
 
January 1, 2018
 
Modified retrospective
 
The adoption had no material impact on the Consolidated Financial Statements. The primary impact was the additional disclosures required in the Notes to Consolidated Financial Statements. See Note 3—Revenue Recognition for additional information.
Clarifying the Definition of a Business
 
Updated the accounting guidance to clarify the definition of a business with the objective of assisting entities with evaluating whether transactions should be accounted for as acquisitions, or disposals, of assets or businesses.
 
January 1, 2018
 
Prospective
 
The adoption had no material impact on the Consolidated Financial Statements.
Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-Retirement Benefit Cost
 
Updated authoritative guidance requires the service cost component of net periodic benefit cost to be presented in the same income statement line item(s) as other employee compensation costs arising from services rendered during the period. The remaining components of net periodic benefit cost are required to be presented separately from the service cost component in an income statement line item outside of operating income. Also, the guidance only allows for the service cost component to be eligible for capitalization. The updated guidance does not impact the accounting for net periodic benefit costs as regulatory assets or liabilities.
 
January 1, 2018
 
Retrospective for the presentation of the service cost component and the other components of net periodic benefit costs on the income statement; prospective for the limitation of capitalization to only the service cost component of net periodic benefit costs in total assets.
 
The Company presented in the current period, and reclassified in the prior period, net periodic benefit costs, other than the service cost component, in Non-operating benefit costs, net on the Consolidated Statements of Operations.

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The following recently issued accounting standards have not yet been adopted by the Company as of March 31, 2018:
Standard
 
Description
 
Date of
Adoption
 
Application
 
Estimated Effect on the Consolidated Financial Statements
Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income
 
Permits entities to reclassify tax effects stranded in accumulated other comprehensive income as a result of the Tax Cuts and Jobs Act (the “TCJA”) to retained earnings.

 
January 1, 2019; early adoption permitted
 
In the period of adoption or retrospective.
 
The Company is evaluating the impact on its Consolidated Financial Statements, as well as the timing of adoption.
Accounting for Leases

 
Updated the accounting and disclosure guidance for leasing arrangements. Under this guidance, a lessee will be required to recognize the following for all leases, excluding short-term leases, at the commencement date: (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the guidance, lessor accounting is largely unchanged.

 
January 1, 2019; early adoption permitted


 
Modified retrospective

 
The Company is evaluating the impact on its Consolidated Financial Statements.


Accounting for Hedging Activities

 
Updated the accounting and disclosure guidance for hedging activities, which allows for more financial and nonfinancial hedging strategies to be eligible for hedge accounting. Under this guidance, a qualitative effectiveness assessment is permitted for certain hedges if an entity can reasonably support an expectation of high effectiveness throughout the term of the hedge, provided that an initial quantitative test establishes that the hedge relationship is highly effective. Also, for cash flow hedges determined to be highly effective, all changes in the fair value of the hedging instrument will be recorded in other comprehensive income with a subsequent reclassification to earnings when the hedged item impacts earnings.

 
January 1, 2019; early adoption permitted

 
Modified retrospective for adjustments related to the measurement of ineffectiveness for cash flow hedges; prospective for the updated presentation and disclosure requirements.

 
The Company does not expect the adoption to have a material impact on its Consolidated Financial Statements based on its hedging activities as of the balance sheet date. The Company is evaluating the timing of adoption.

Simplification of Goodwill Impairment Testing
 
Updated authoritative guidance which simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under the amendments in the update, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying value exceeds the reporting unit’s fair value, however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary.
 
January 1, 2020; early adoption permitted
 
Prospective
 
The Company is evaluating the impact on its Consolidated Financial Statements, as well as the timing of adoption.

Measurement of Credit Losses
 
Updated the accounting guidance on reporting credit losses for financial assets held at amortized cost basis and available-for-sale debt securities. Under this guidance, expected credit losses are required to be measured based on historical experience, current conditions and reasonable and supportable forecasts that affect the collectability of the reported amount of financial assets. Also, this guidance requires that credit losses on available-for-sale debt securities be presented as an allowance rather than as a direct write-down.
 
January 1, 2020; early adoption permitted
 
Modified retrospective
 
The Company is evaluating the impact on its Consolidated Financial Statements, as well as the timing of adoption.
Cash, Cash Equivalents and Restricted Funds
The following table provides a reconciliation of the cash, cash equivalents and restricted funds as presented on the Consolidated Balance Sheets, to the sum of such amounts presented on the Consolidated Statements of Cash Flows for the periods ended March 31:
 
2018
 
2017
Cash and cash equivalents
$
55

 
$
78

Restricted funds
26

 
23

Restricted funds included in other long-term assets
1

 
4

Cash and cash equivalents and restricted funds as presented on the Consolidated Statements of Cash Flows
$
82

 
$
105

Reclassifications
Certain reclassifications have been made to prior periods in the accompanying Consolidated Financial Statements and notes to conform to the current presentation.

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Note 3: Revenue Recognition
On January 1, 2018, the Company adopted Accounting Standards Codification Topic 606, Revenue From Contracts With Customers, and all related amendments (collectively, “ASC 606” or the “standard”), using the modified retrospective approach, applied to contracts which were not completed as of January 1, 2018. Under this approach, periods prior to the adoption date have not been restated and continue to be reported under the accounting standards in effect for those periods. The Company’s revenue associated with alternative revenue programs and lease contracts are outside the scope of ASC 606 and accounted for under other existing GAAP.
Under ASC 606, a performance obligation is a promise within a contract to transfer a distinct good or service, or a series of distinct goods and services, to a customer. Revenue is recognized when performance obligations are satisfied and the customer obtains control of promised goods or services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for goods or services. Under the standard, a contract’s transaction price is allocated to each distinct performance obligation. To determine revenue recognition for arrangements that the Company determines are within the scope of ASC 606, the Company performs the following five steps: (i) identifies the contracts with a customer; (ii) identifies the performance obligations within the contract, including whether they are distinct and capable of being distinct in the context of the contract; (iii) determines the transaction price; (iv) allocates the transaction price to the performance obligations in the contract; and (v) recognizes revenue when, or as, the Company satisfies each performance obligation.
The Company’s revenues from contracts with customers are discussed below. Customer payments for contracts are generally due within 30 days of billing and none of the contracts with customers have payment terms that exceed one year; therefore, the Company elected to apply the significant financing component practical expedient and no amount of consideration has been allocated as a financing component. See Note 14—Segment Information for additional information regarding the Company’s operating segments.
Regulated Businesses Revenue
Revenue from the Company’s Regulated Businesses is generated primarily from water and wastewater services delivered to customers. These contracts contain a single performance obligation, the delivery of water and wastewater services, as the promise to transfer the individual good or service is not separately identifiable from other promises within the contract and, therefore, is not distinct. Revenues are recognized over time, as services are provided. There are generally no significant financing components or variable consideration. Revenues include amounts billed to customers on a cycle basis, and unbilled amounts calculated based on estimated usage from the date of the meter reading associated with the latest customer bill, to the end of the accounting period. The amounts that the Company has a right to invoice are determined by each customer’s actual usage, an indicator that the invoice amount corresponds directly to the value transferred to the customer. The Company elected to use the right to invoice and the disclosure of remaining performance obligations practical expedients for these revenues.
Market-Based Businesses Revenue
Through various protection programs, the Company provides fixed fee services to domestic homeowners and smaller commercial customers to protect against repair costs for interior and external water and sewer lines, interior electric lines, heating and cooling systems and water heaters, as well as power surge protection and other related services. All contracts have a one-year term and each service is a separate performance obligation, satisfied over time, as the customers simultaneously receive and consume the benefits provided from the service. Customers are obligated to pay for the protection programs ratably over 12 months or via a one-time, annual fee, with revenues recognized ratably over time for these services. Advances from customers are deferred until the performance obligation is satisfied. The Company elected to use the disclosure of remaining performance obligations practical expedients for these revenues.

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The Company’s Market-Based Businesses also have long-term, fixed fee contracts to operate and maintain water and wastewater facilities with the U.S. government on various military bases and facilities owned by municipal and industrial customers, as well as shorter-term contracts that provide water management solutions for shale natural gas companies and customers in the water services market. Billing and revenue recognition for the fixed fee revenues occurs ratably over the term of the contract, as customers simultaneously receive and consume the benefits provided by the Company. Additionally, these contracts allow the Company to make capital improvements to underlying infrastructure, which are initiated through separate modifications or amendments to the original contract, whereby stand-alone, fixed pricing is separately stated for each improvement. The Company has determined that these capital improvements are separate performance obligations, with revenue recognized over time based on performance completed at the end of each reporting period. The Company elected to use the significant financing component practical expedient for these contract revenues. Losses on contracts are recognized during the period in which the loss first becomes probable and estimable. Revenues recognized during the period in excess of billings on construction contracts are recorded as unbilled revenues, with billings in excess of revenues recorded as other (current liabilities) until the recognition criteria are met. Changes in contract performance and related estimated contract profitability may result in revisions to costs and revenues, and are recognized in the period in which revisions are determined.
Disaggregated Revenues
The following table is a summary of the Company’s operating revenues disaggregated for the three months ended March 31, 2018:
(In millions)
Revenues from Contracts with Customers
 
Other Revenues not from Contracts with Customers (a)
 
Total Operating Revenues
Regulated Businesses:
 
 
 
 
 
Water services:
 
 
 
 
 
Residential
$
368

 
$

 
$
368

Commercial
133

 

 
133

Industrial
31

 

 
31

Public and other
80

 

 
80

Total water services
612

 

 
612

Wastewater services:
 

 
 
 
 
Residential
27

 

 
27

Commercial
7

 

 
7

Industrial
1

 

 
1

Public and other
3

 

 
3

Total wastewater services
38

 

 
38

Miscellaneous utility charges
11

 

 
11

Alternative revenue programs revenue

 
3

 
3

Lease revenue

 
2

 
2

Total Regulated Businesses
661

 
5

 
666

Market-Based Businesses
100

 

 
100

Other
(5
)
 

 
(5
)
Total operating revenues
$
756

 
$
5

 
$
761

(a)
Includes revenues associated with alternative revenue programs and lease contracts which are outside the scope of ASC 606 and accounted for under other existing GAAP.

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Contract Balances
Contract assets and contract liabilities are the result of timing differences between revenue recognition, billings and cash collections. In the Company’s Market-Based Businesses, certain contracts are billed as work progresses in accordance with agreed-upon contractual terms, either at periodic intervals or upon achievement of contractual milestones. Contract assets are recorded when billing occurs subsequent to revenue recognition, and are reclassified to accounts receivable when billed and the right to consideration becomes unconditional. Contract liabilities are recorded when the Company receives advances from customers prior to satisfying contractual performance obligations, particularly for construction contracts and protection program contracts, and are recognized as revenue when the associated performance obligations are satisfied. Contract assets are included in unbilled revenues and contract liabilities are in included in other (current liabilities) on the Consolidated Balance Sheets as of March 31, 2018.
The following table summarizes the changes in contract assets and liabilities for the three months ended March 31, 2018:
(In millions)
 
Contract assets:
 
Balance at January 1, 2018
$
35

Additions
7

Transfers to accounts receivable, net
(23
)
Balance at March 31, 2018
$
19

 
 
Contract liabilities:
 
Balance at January 1, 2018
$
25

Additions
26

Transfers to operating revenues
(22
)
Balance at March 31, 2018
$
29

Remaining Performance Obligations
Remaining performance obligations (“RPOs”) represent revenues the Company expects to recognize in the future from contracts that are in progress. As of March 31, 2018, the Company’s operation and maintenance and capital improvement contracts in the Market-Based Businesses have RPOs. Contracts with the U.S. government for work on various military bases expire between 2051 and 2068 and have RPOs of $3.8 billion as of March 31, 2018, as measured by estimated remaining contract revenue. Such contracts are subject to customary termination provisions held by the U.S. government, prior to the agreed-upon contract expiration. Contracts with municipalities and commercial customers expire between 2018 and 2038 and have RPOs of $690 million as of March 31, 2018, as measured by estimated remaining contract revenue.
Note 4: Acquisitions
During the three months ended March 31, 2018, the Company closed on three acquisitions of various regulated water and wastewater systems for a total aggregate purchase price of $8 million. Assets acquired in the aforementioned acquisitions, principally utility plant, totaled $9 million. Liabilities assumed totaled $1 million, including $1 million of contributions in aid of construction. See Note 15—Subsequent Events for discussion relating to the pending acquisitions of Pivotal Home Solutions (“Pivotal”) and the City of Alton, Illinois’ regional wastewater system.
Note 5: Regulatory Liabilities
On December 22, 2017, the TCJA was signed into law, which, among other things, enacted significant and complex changes to the Internal Revenue Code of 1986, including a reduction in the federal corporate income tax rate from 35% to 21% as of January 1, 2018. Fourteen of the Company’s regulatory jurisdictions have either opened separate proceedings to address the TCJA, or are planning to incorporate the impacts of the TCJA in existing proceedings. The Company expects its regulated customers to benefit from the tax savings resulting from the TCJA and, as a result, recorded a $32 million reserve on revenue earned during the first quarter of 2018, for the estimated tax savings resulting from the TCJA; and a corresponding regulatory liability, of which, the current portion is $23 million and is recorded in other (current liabilities), and the long-term portion is $9 million and is recorded in regulatory liabilities on the Consolidated Balance Sheet as of March 31, 2018.

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Note 6: Stockholders' Equity
Accumulated Other Comprehensive Loss
The following table presents changes in accumulated other comprehensive loss by component, net of tax, for the three months ended March 31, 2018 and 2017, respectively:
 
Defined Benefit Plans
 
Foreign Currency Translation
 
Gain on Cash Flow Hedges
 
Accumulated Other Comprehensive Loss
 
Employee
Benefit Plan
Funded Status
 
Amortization
of Prior
Service Cost
 
Amortization
of Actuarial
(Gain) Loss
 
 
 
Beginning balance as of December 31, 2017
$
(140
)
 
$
1

 
$
49

 
$
1

 
$
10

 
$
(79
)
Other comprehensive income before reclassifications

 

 

 

 
6

 
6

Amounts reclassified from accumulated other comprehensive loss

 

 
(2
)
 

 

 
(2
)
Net other comprehensive income (loss)

 

 
(2
)
 

 
6

 
4

Ending balance as of March 31, 2018
$
(140
)
 
$
1

 
$
47

 
$
1

 
$
16

 
$
(75
)
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance as of December 31, 2016
$
(147
)
 
$
1

 
$
42

 
$
2

 
$
16

 
$
(86
)
Other comprehensive income (loss) before reclassifications

 

 

 
(1
)
 
3

 
2

Amounts reclassified from accumulated other comprehensive loss

 

 
2

 

 

 
2

Net other comprehensive income (loss)

 

 
2

 
(1
)
 
3

 
4

Ending balance as of March 31, 2017
$
(147
)
 
$
1

 
$
44

 
$
1

 
$
19

 
$
(82
)
The Company does not reclassify the amortization of defined benefit pension cost components from accumulated other comprehensive loss directly to net income in its entirety, as a portion of these costs have been capitalized as a regulatory asset. These accumulated other comprehensive income loss components are included in the computation of net periodic pension cost. See Note 10—Pension and Other Post-Retirement Benefits.
The amortization of the gain on cash flow hedges is reclassified to net income during the period incurred and is included in interest, net in the accompanying Consolidated Statements of Operations.
Anti-dilutive Stock Repurchase Program
During the three months ended March 31, 2018, the Company repurchased 0.6 million shares of common stock in the open market at an aggregate cost of $45 million under the anti-dilutive stock repurchase program authorized by the Company’s Board of Directors in 2015. As of March 31, 2018, there were 5.5 million shares of common stock available for repurchase under the program.
Forward Sale Agreements
See Note 15—Subsequent Events for discussion relating to the forward sale agreements entered into by the Company on April 11, 2018 and the related potential impacts on the Company’s stockholders’ equity.
Note 7: Long-Term Debt
The following long-term debt was issued during the three months ended March 31, 2018:
Company
 
Type
 
Rate
 
Maturity
 
Amount
Other American Water subsidiaries
 
Private activity bonds and government funded debt—fixed rate (a)
 
0.00%
 
2020-2021
 
$
10

Total issuances
 
 
 
 
 
 
 
$
10

(a)
This long-term debt relates to the New Jersey Environmental Infrastructure Financing Program.

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The following long-term debt was retired through sinking fund provisions, optional redemptions or payment at maturity during the three months ended March 31, 2018:
Company
 
Type
 
Rate
 
Maturity
 
Amount
American Water Capital Corp.
 
Private activity bonds and government funded debt—fixed rate
 
1.79%-2.90%
 
2021-2031
 
$
1

Other American Water subsidiaries
 
Private activity bonds and government funded debt—fixed rate
 
0.00%-5.40%
 
2018-2041
 
3

Other American Water subsidiaries
 
Term Loan
 
4.83%-5.38%
 
2021
 
1

Other American Water subsidiaries
 
Mandatorily redeemable preferred stock
 
8.49%
 
2036
 
1

Total retirements and redemptions
 
 
 
 
 
 
 
$
6

The Company has two forward starting swap agreements, each with a notional amount of $100 million, to reduce interest rate exposure on debt expected to be issued in 2018. These forward starting swap agreements terminate in November 2018 and have an average fixed rate of 2.59%. The Company has designated these forward starting swap agreements as cash flow hedges with their fair value recorded in accumulated other comprehensive gain or loss. Upon termination, the cumulative gain or loss recorded in accumulated other comprehensive gain or loss will be amortized through interest, net over the term of the new debt.
The Company has employed interest rate swaps to fix the interest cost on a portion of its variable-rate debt with an aggregate notional amount of $5 million. The Company has designated these interest rate swaps as economic hedges accounted for at fair value with gains or losses deferred as a regulatory asset or regulatory liability. The net gain recognized by the Company for the three months ended March 31, 2018 and 2017 was de minimis.
No ineffectiveness was recognized on hedging instruments for the three months ended March 31, 2018 and 2017.
The following table provides a summary of the gross fair value for the Company’s derivative asset and liabilities, as well as the location of the asset and liability balances on the Consolidated Balance Sheets:
Derivative Instruments
 
Derivative Designation
 
Balance Sheet Classification
 
March 31, 2018
 
December 31, 2017
Asset derivative:
 
 
 
 
 
 

 
 

Forward starting swaps
 
Cash flow hedge
 
Other current assets
 
$
6

 
$

 
 
 
 
 
 
 
 
 
Liability derivative:
 
 
 
 
 
 

 
 

Forward starting swaps
 
Cash flow hedge
 
Other current liabilities
 

 
3

Note 8: Short-Term Debt
On March 21, 2018, AWCC and its lenders amended and restated the credit agreement with respect to AWCC’s revolving credit facility to increase the maximum commitments under the facility to $2.25 billion from $1.75 billion and to extend the expiration date of the facility to March 2023 from June 2020. The facility is used principally to support AWCC’s commercial paper program and to provide a sub-limit of up to $150 million for letters of credit. As of March 31, 2018, no amounts were borrowed by AWCC under the credit agreement, except with respect to the letters of credit issued under the $150 million letter of credit sub-limit. Subject to satisfying certain conditions, the credit agreement also permits AWCC to increase the maximum commitment under the facility by up to an aggregate of $500 million and to request extensions of its expiration date for up to two one-year periods. The financial covenants with respect to the facility remained unchanged from the credit agreement in effect on December 31, 2017.
On March 21, 2018, AWCC increased the maximum aggregate principal amount of borrowings authorized under its commercial paper program from $1.60 billion to $2.10 billion. As of March 31, 2018, AWCC had $1.18 billion in commercial paper outstanding.
Note 9: Income Taxes
The Company’s effective income tax rate was 24.3% and 35.9% for the three months ended March 31, 2018 and 2017, respectively. The decrease of the Company’s effective income tax rate primarily resulted from the reduction in the federal corporate income tax rate from 35% to 21% as of January 1, 2018 from the enactment of the TCJA. There were no significant adjustments recorded during the first quarter of 2018 pursuant to Staff Accounting Bulletin 118.

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Note 10: Pension and Other Post-Retirement Benefits
The following table provides the components of net periodic benefit (credit) costs:
 
For the Three Months Ended March 31,
 
2018
 
2017
Components of net periodic pension benefit cost:
 
 
 
Service cost
$
9

 
$
9

Interest cost
19

 
20

Expected return on plan assets
(25
)
 
(24
)
Amortization of actuarial loss
7

 
9

Net periodic pension benefit cost
$
10

 
$
14

 
 
 
 
Components of net periodic other post-retirement benefit (credit) cost:
 
 
 
Service cost
$
3

 
$
3

Interest cost
6

 
7

Expected return on plan assets
(7
)
 
(7
)
Amortization of prior service credit
(5
)
 
(5
)
Amortization of actuarial loss
1

 
3

Net periodic other post-retirement benefit (credit) cost
$
(2
)
 
$
1

The Company made no contributions for the funding of its defined benefit pension plans for the three months ended March 31, 2018 and $10 million for the three months ended March 31, 2017, respectively. In addition, the Company made no contributions for the funding of its other post-retirement plans for the three months ended March 31, 2018 and $1 million for the three months ended March 31, 2017, respectively. The Company expects to make pension and post-retirement contributions to the plan trusts of up to $45 million during the remainder of 2018.
Note 11: Commitments and Contingencies
Contingencies
The Company is routinely involved in legal actions incident to the normal conduct of its business. As of March 31, 2018, the Company has accrued approximately $135 million of probable loss contingencies and has estimated that the maximum amount of losses associated with reasonably possible loss contingencies that can be reasonably estimated is $25 million. For certain matters, claims and actions, the Company is unable to estimate possible losses. The Company believes that damages or settlements, if any, recovered by plaintiffs in such matters, claims or actions, other than as described in this Note 11—Commitments and Contingencies, will not have a material adverse effect on the Company.
West Virginia Elk River Freedom Industries Chemical Spill
Background
On January 9, 2014, a chemical storage tank owned by Freedom Industries, Inc. leaked two substances, 4-methylcyclohexane methanol (“MCHM”), and PPH/DiPPH, a mix of polyglycol ethers, into the Elk River near the West Virginia-American Water Company (“WVAWC”) treatment plant intake in Charleston, West Virginia. After having been alerted to the leak of MCHM by the West Virginia Department of Environmental Protection, WVAWC took immediate steps to gather more information about MCHM, augment its treatment process 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 MCHM, a joint decision was reached in consultation with the West Virginia Bureau for Public Health to issue a “Do Not Use” order for all of its approximately 93,000 customer accounts in parts of nine West Virginia counties served by the Charleston treatment plant. By January 18, 2014, none of WVAWC’s customers were subject to the Do Not Use order.

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Following the Freedom Industries chemical spill, numerous lawsuits were filed against WVAWC and certain other Company affiliated entities (collectively, the “American Water Defendants”) with respect to this matter in the U.S. District Court for the Southern District of West Virginia or West Virginia Circuit Courts in Kanawha, Boone and Putnam counties, and to date, more than 70 cases remain pending. Four of the cases pending before the U.S. district court were consolidated for purposes of discovery, and an amended consolidated class action complaint for those cases (the “Federal action”) was filed in December 2014 by several plaintiffs. In January 2016, all of the then-filed state court cases were referred to West Virginia’s Mass Litigation Panel for further proceedings, which have been stayed until July 27, 2018 pending the approval by the court in the Federal action of a global agreement to settle all of such cases, as described below. The court in the Federal action has continued the start of the trial indefinitely pending ongoing settlement approval activities.
Proposed Global Class Action Settlement
On September 21, 2017, the court in the Federal action issued an order granting preliminary approval of a settlement class and proposed class action settlement (the “Settlement”) with respect to claims against the American Water Defendants by all putative class members (collectively, the “Plaintiffs”) for all claims and potential claims arising out of the Freedom Industries chemical spill. The Settlement proposes a global resolution of all federal and state litigation and potential claims against the American Water Defendants and their insurers. Under the terms and conditions of the Settlement and the proposed amended settlement agreement, the American Water Defendants have not admitted, and will not admit, any fault or liability for any of the allegations made by the Plaintiffs in any of the actions to be resolved. Under federal class action rules, claimants had the right, until December 8, 2017, to elect to opt out of the final Settlement, in which case such claimant would not receive any benefit from or be bound by the terms of the Settlement. Less than 100 of the 225,000 estimated putative Plaintiffs have submitted opt-out notices. The deadline to file a claim in the Settlement expired on February 21, 2018.
The proposed aggregate pre-tax amount of the Settlement with respect to the Company is $126 million. The aggregate portion of the Settlement to be contributed by WVAWC, net of insurance recoveries, is $43 million (approximately $26 million after tax), taking into account the September 2017 settlement with one of the Company’s general liability insurance carriers discussed below. Another defendant to the Settlement is to contribute up to $25 million to the Settlement. Two of the Company’s insurance carriers, which provide an aggregate of $50 million in insurance coverage to the Company under the Company’s general liability insurance program, had been originally requested to participate in the Settlement at the time of the initial filing of the binding agreement in principle with the court in the Federal action, but did not agree to do so at that time. WVAWC filed a lawsuit against one of these carriers alleging that the carrier’s failure to agree to participate in the Settlement constituted a breach of contract. On September 19, 2017, the Company and the insurance carrier settled this lawsuit for $22 million, out of a maximum of $25 million in potential coverage under the terms of the relevant policy, in exchange for a full release by the Company and WVAWC of all claims against the insurance carrier related to the Freedom Industries chemical spill. WVAWC and the settling insurer have agreed to stay this litigation pending final approval of the Settlement. The Company and WVAWC continue to pursue vigorously their rights to insurance coverage for contributions by WVAWC to the Settlement in mandatory arbitration with the remaining non-participating carrier. This arbitration proceeding remains pending.
The proposed Settlement would establish a two-tier settlement fund for the payment of claims, comprised of (i) a simple claim fund, which is also referred to as the “guaranteed fund,” of $76 million, of which $29 million will be contributed by WVAWC, including insurance deductibles, and $47 million would be contributed by two of the Company’s general liability insurance carriers, and (ii) an individual review claim fund of up to $50 million, of which up to $14 million would be contributed by WVAWC and up to $36 million would be contributed by a number of the Company’s general liability insurance carriers. Separately, up to $25 million would be contributed to the guaranteed fund by another defendant to the Settlement. If any final approval order by the court in the Federal action with respect to the Settlement is appealed and such appeal would delay potential payment to claimants under the Settlement, WVAWC and the other defendant to the Settlement will contribute up to $50 million and $25 million, respectively, to the Settlement (not including, in the case of WVAWC, any contributions by the Company’s general liability insurance carriers which would not be made until such time as a final, non-appealable order is issued) into an escrow account during the pendency of such appeals. For certain claims, WVAWC and the other defendant to the Settlement may, in lieu of these escrowed contributions, make advance payments of such claims if agreed to by the parties. All administrative expenses of the Settlement and attorneys’ fees of class counsel related thereto would be paid from the funds designated to pay claims covered by the Settlement.
The settlement amount of $126 million is reflected in Accrued Liabilities and the offsetting insurance receivables are reflected in Other Current Assets on the Consolidated Balance Sheet as of March 31, 2018. The Company intends to fund WVAWC’s contributions to the Settlement through existing sources of liquidity, although no contribution by WVAWC will be required unless and until the terms of the Settlement are finally approved by the court in the Federal action. Furthermore, under the terms of the Settlement, WVAWC has agreed that it will not seek rate recovery from the Public Service Commission of West Virginia (the “PSC”) for approximately $4 million in direct response costs expensed in 2014 by WVAWC relating to the Freedom Industries chemical spill as well as for amounts paid by WVAWC under the Settlement.

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The Company’s insurance policies operate under a layered structure where coverage is generally provided in the upper layers after claims have exhausted lower layers of coverage. The insurance carrier that was requested, but presently has not agreed, to participate in the Settlement ranks lower in the general liability insurance structure than the insurance carriers that have agreed to contribute $36 million to the individual review claim fund, as noted above. As such, the non-participating carrier would have ordinarily be required to respond to pay a claim prior to the participating carriers. Any recovery by WVAWC or the Company from the remaining non-participating carrier would reimburse WVAWC for its contributions to the guaranteed fund.
Following completion of the required class member notice period, on January 9, 2018, the court in the Federal action held a fairness hearing to consider final approval of the Settlement, which was continued on February 1, 2018 to address certain open matters. At this hearing, the court in the Federal action indicated that it intended to enter an order approving the Settlement, and the parties submitted a proposed order to the court on February 2, 2018.
Other Related Proceedings
Additionally, investigations with respect to the matter have been initiated by the U.S. Chemical Safety and Hazard Investigation Board (the “CSB”), the U.S. Attorney’s Office for the Southern District of West Virginia, the West Virginia Attorney General, and the PSC. As a result of the U.S. Attorney’s Office investigation, Freedom Industries and six former Freedom Industries employees (three of whom also were former owners of Freedom Industries), pled guilty to violations of the federal Clean Water Act. Moreover, the PSC issued an order on June 15, 2017 concluding its investigation without requiring WVAWC to take any further action with respect to the matters covered by the general investigation.
The CSB is an independent investigatory agency with no regulatory mandate or ability to issue fines or citations; rather, the CSB can only issue recommendations for further action. In response to the Freedom Industries chemical spill, the CSB commenced an investigation shortly thereafter. In September, 2016, the CSB issued and adopted its investigation report in which it recommended that the Company conduct additional source water protection activities. On April 4, 2017, the CSB indicated that the implementation by the Company of source water protection activities resolved the first two parts of the CSB’s recommendation. On March 5, 2018, based on information the Company provided to the CSB, the CSB closed its investigation with a status of “acceptable action,” which refers to the Company’s actions on all three parts of the CSB’s recommendation.
On March 16, 2017, the Lincoln County (West Virginia) Commission (the “LCC”) passed a county ordinance entitled the “Lincoln County, WV Comprehensive Public Nuisance Investigation and Abatement Ordinance.” The ordinance establishes a mechanism that Lincoln County believes will allow it to pursue criminal or civil proceedings for the “public nuisance” it alleges was caused by the Freedom Industries chemical spill. On April 20, 2017, the LCC filed a complaint in Lincoln County state court against WVAWC and certain other defendants not affiliated with the Company, alleging that the Freedom Industries chemical spill caused a public nuisance in Lincoln County. The complaint seeks an injunction against WVAWC that would require the creation of various databases and public repositories of documents related to the Freedom Industries chemical spill, as well as further study and risk assessments regarding the alleged exposure of Lincoln County residents to the released chemicals. On June 12, 2017, the Mass Litigation Panel entered an order granting a motion to transfer this case to its jurisdiction and stayed the case consistent with the existing stay order. The LCC has elected to opt out of the Settlement. On January 26, 2018, the LCC filed a motion seeking to lift the stay imposed by the Mass Litigation Panel. On March 5, 2018, this motion was denied. WVAWC believes that this lawsuit is without merit and intends to vigorously contest the claims and allegations raised in the complaint.
California Public Utilities Commission Residential Rate Design Proceeding
On April 9, 2018, the California Public Utilities Commission (the “CPUC”) issued a presiding officer’s decision (“POD”) granting the motion for adoption of the Joint Settlement Agreement (described below) to resolve the CPUC’s residential tariff administration proceeding. The POD provides for a waiver by California-American Water Company, a wholly owned subsidiary of the Company (“Cal Am”), of $0.5 million of cost recovery for residential customers through the water revenue adjustment mechanism/modified cost balancing account (“WRAM/MCBA”), in lieu of a penalty. Any party or any CPUC commissioner may file an appeal of the POD by May 9, 2018. If no appeal is filed, the decision will become final.
The POD relates initially to a final CPUC decision issued in December 2016 in a proceeding involving Cal Am, adopting a new residential rate design for Cal Am’s Monterey District. The decision allowed for recovery by Cal Am of $32 million in under-collections in the WRAM/MCBA over a five-year period, plus interest, and modified existing conservation and rationing plans. In its decision, the CPUC noted concern regarding Cal Am’s residential tariff administration, specifically regarding the lack of verification of customer-provided information about the number of residents per household. This information was used for generating billing determinants under the tiered rate system. As a result, the CPUC kept this proceeding open to address several issues, including whether Cal Am’s residential tariff administration violated a statute, rule or CPUC decision, and if so, whether a penalty should be imposed.

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On February 24, 2017, Cal Am, the Monterey Peninsula Water Management District, the CPUC’s Office of Ratepayer Advocates, and the Coalition of Peninsula Businesses, filed for CPUC approval of a joint settlement agreement (the “Joint Settlement Agreement”), which among other things, proposed to resolve the CPUC’s residential tariff administration concerns by providing for a waiver by Cal Am of $0.5 million of cost recovery for residential customers through the WRAM/MCBA in lieu of a penalty. On March 28, 2017, the administrative law judge assigned to the proceeding issued a ruling stating there was sufficient evidence to conclude, on a preliminary basis, that Cal Am’s administration of the residential tariff violated certain provisions of the California Public Utilities Code and a CPUC decision. This ruling ordered Cal Am to show cause why it should not be penalized for these administrative violations and directed the settling parties to address whether the cost recovery waiver in the Joint Settlement Agreement was reasonable compared to a potential penalty range ultimately clarified by the administrative law judge to be from $3 million to $179 million. However, in the April 9, 2018 POD, the administrative law judge found that Cal Am’s administration of the residential tariff did not in fact violate the California Public Utilities Code or a CPUC decision, which was a significant departure from the judge’s March 28, 2017 ruling. The POD essentially reverses the CPUC’s position expressed in the earlier ruling.
As of March 31, 2018, the portions of this loss contingency that are probable and/or reasonably possible have been determined to be immaterial to the Company and have been included in the aggregate maximum amounts described above in the paragraph under “Contingencies” in this Note 11—Commitments and Contingencies.
Dunbar, West Virginia Water Main Break Class Action Litigation
On the evening of June 23, 2015, a 36-inch pre-stressed concrete transmission water main, installed in the early 1970s, failed. The water main is part of WVAWC’s West Relay pumping station located in the City of Dunbar. The failure of the main caused water outages and low pressure to up to approximately 25,000 WVAWC customers. In the early morning hours of June 25, 2015, crews completed a repair, but that same day, the repair developed a leak. On June 26, 2015, a second repair was completed and service was restored that day to approximately 80% of the impacted customers, and to the remaining approximately 20% by the next morning. The second repair showed signs of leaking but the water main was usable until June 29, 2015 to allow tanks to refill. The system was reconfigured to maintain service to all but approximately 3,000 customers while a final repair was completed safely on June 30, 2015. Water service was fully restored by July 1, 2015 to all customers affected by this event.
On June 2, 2017, a class action complaint was filed in West Virginia Circuit Court in Kanawha County against WVAWC on behalf of a purported class of residents and business owners who lost water service or pressure as a result of the Dunbar main break. The complaint alleges breach of contract by WVAWC for failure to supply water, violation of West Virginia law regarding the sufficiency of WVAWC’s facilities and negligence by WVAWC in the design, maintenance and operation of the water system. The plaintiffs seek unspecified alleged damages on behalf of the class for lost profits, annoyance and inconvenience, and loss of use, as well as punitive damages for willful, reckless and wanton behavior in not addressing the risk of pipe failure and a large outage.
On October 12, 2017, WVAWC filed with the court a motion seeking to dismiss all of the plaintiffs’ counts alleging statutory and common law tort claims. Furthermore, WVAWC asserts that the PSC, and not the court, has primary jurisdiction over allegations involving violations of the applicable tariff, the public utility code and related rules. This motion remains pending.
The Company and WVAWC believe that WVAWC has valid, meritorious defenses to the claims raised in this class action complaint. WVAWC is vigorously defending itself against these allegations. Given the current stage of this proceeding, the Company cannot reasonably estimate the amount of any reasonably possible losses or a range of such losses related to this proceeding.
Note 12: Earnings per Common Share
The following table is a reconciliation of the numerator and denominator for basic and diluted earnings per share calculations:
 
For the Three Months Ended March 31,
 
2018
 
2017
Numerator:
 
 
 
Net income attributable to common stockholders
$
106

 
$
93

 
 
 
 
Denominator:
 

 
 

Weighted-average common shares outstanding—Basic
178

 
178

Effect of dilutive common stock equivalents
1

 
1

Weighted-average common shares outstanding—Diluted
179

 
179


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The effect of dilutive common stock equivalents is related to outstanding stock options, restricted stock units and performance stock units granted under the 2007 and the 2017 Omnibus Equity Compensation Plans, as well as shares purchased under the American Water Works Company, Inc. and its Designated Subsidiaries 2017 Nonqualified Employee Stock Purchase Plan. Less than one million share-based awards were excluded from the computation of diluted EPS for the three months ended March 31, 2018 and 2017 because their effect would have been anti-dilutive under the treasury stock method.
Forward Sale Agreements
See Note 15—Subsequent Events for discussion relating to the forward sale agreements entered into by the Company on April 11, 2018 and the related potential impacts on the Company’s diluted earnings per common share.
Note 13: Fair Value of Financial Assets and Liabilities
Fair Values 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 on the 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 Level 3 are determined by a valuation model that is based on a conventional discounted cash flow methodology and utilizes assumptions of current market rates. As a majority of the Company’s debt is not traded in active markets, 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 A 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.
The carrying amounts including fair value adjustments previously recognized in acquisition purchase accounting and a fair value adjustment related to the Company’s interest rate swap fair value hedge (which is classified as Level 2 in the fair value hierarchy), and fair values of the financial instruments were as follows:
 
Carrying Amount
 
At Fair Value as of March 31, 2018
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Preferred stock with mandatory redemption requirements
$
9

 
$

 
$

 
$
12

 
$
12

Long-term debt (excluding capital lease obligations)
6,814

 
4,630

 
959

 
1,782

 
7,371

 
 
 
 
 
 
 
 
 
 
 
Carrying Amount
 
At Fair Value as of December 31, 2017
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Preferred stock with mandatory redemption requirements
$
10

 
$

 
$

 
$
14

 
$
14

Long-term debt (excluding capital lease obligations)
6,809

 
4,846

 
976

 
1,821

 
7,643


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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 March 31, 2018 and December 31, 2017 respectively:
 
At Fair Value as of March 31, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Restricted funds
$
28

 
$

 
$

 
$
28

Rabbi trust investments
15

 

 

 
15

Deposits
4

 

 

 
4

Mark-to-market derivative asset

 
6

 

 
6

Other investments
5

 

 

 
5

Total assets
52

 
6

 

 
58

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Deferred compensation obligations
17

 

 

 
17

Total liabilities
17

 

 

 
17

Total net assets (liabilities)
$
35

 
$
6

 
$

 
$
41

 
At Fair Value as of December 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Restricted funds
$
28

 
$

 
$

 
$
28

Rabbi trust investments
15

 

 

 
15

Deposits
4

 

 

 
4

Other investments
3

 

 

 
3

Total assets
50

 

 

 
50

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Deferred compensation obligations
17

 

 

 
17

Mark-to-market derivative liabilities

 
3

 

 
3

Total liabilities
17

 
3

 

 
20

Total net assets (liabilities)
$
33

 
$
(3
)
 
$

 
$
30

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, maintenance and repair projects. Long-term restricted funds of $1 million were included in other long-term assets as of March 31, 2018 and December 31, 2017, respectively.
Rabbi trust investments—The Company’s rabbi trust investments consist of equity and index funds from which supplemental executive retirement plan benefits and deferred compensation obligations can be 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.
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.

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Mark-to-market derivative liabilities—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 also employs derivative financial instruments in the form of variable-to-fixed interest rate swaps and forward starting interest rate swaps, classified as economic hedges and cash flow hedges, respectively, in order to fix the interest cost on existing or forecasted 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.
Other investments—Other investments primarily represent money market funds used for active employee benefits. The Company includes other investments in other current assets.
Note 14: Segment Information
The Company operates its businesses primarily through one reportable segment, the Regulated Businesses segment. The Company also operates businesses that provide a broad range of related and complementary water and wastewater services in non-regulated markets, which includes four operating segments that individually do not meet the criteria of a reportable segment. These four non-reportable operating segments are collectively presented as the “Market-Based Businesses.” “Other” includes corporate costs that are not allocated to the Company’s operating segments, eliminations of inter-segment transactions, fair value adjustments and associated income and deductions related to the acquisitions that have not been allocated to the operating segments for evaluation of performance and allocation of resource purposes. The following tables include the Company’s summarized segment information:
 
As of or for the Three Months Ended March 31, 2018
 
Regulated
Businesses
 
Market-Based
Businesses
 
Other
 
Consolidated
Operating revenues
$
666

 
$
100

 
$
(5
)
 
$
761

Depreciation and amortization
122

 
4

 
3

 
129

Total operating expenses, net
462

 
86

 
(4
)
 
544

Interest, net
(69
)
 
1

 
(16
)
 
(84
)
Income before income taxes
142

 
16

 
(18
)
 
140

Provision for income taxes
38

 
4

 
(8
)
 
34

Net income attributable to common stockholders
104

 
12

 
(10
)
 
106

Total assets
17,817

 
604

 
1,307

 
19,728

 
As of or for the Three Months Ended March 31, 2017
 
Regulated
Businesses
 
Market-Based
Businesses
 
Other
 
Consolidated
Operating revenues
$
659

 
$
103

 
$
(6
)
 
$
756

Depreciation and amortization
117

 
4

 
3

 
124

Total operating expenses, net
438

 
94

 
(6
)
 
526

Interest, net
(66
)
 

 
(19
)
 
(85
)
Income before income taxes
154

 
10

 
(19
)
 
145

Provision for income taxes
60

 
3

 
(11
)
 
52

Net income attributable to common stockholders
94

 
7

 
(8
)
 
93

Total assets
16,632

 
555

 
1,423

 
18,610


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Note 15: Subsequent Events
Pivotal Home Solutions Acquisition Agreement
On April 11, 2018 the Company, through its subsidiary American Water Enterprises, LLC (“AWE”), entered into a stock purchase agreement to acquire (the “Acquisition”) all of the capital stock of Nicor Energy Services Company, doing business as Pivotal Home Solutions (“Pivotal”), from Nicor Energy Ventures Company Gas (“Nicor”), a subsidiary of Southern Company Gas. Pivotal is headquartered in Naperville, Illinois and is a provider of home warranty protection products and services, operating in 18 states with approximately 1.2 million customer contracts. Under the terms of the stock purchase agreement, AWE will purchase from Nicor all of Pivotal’s capital stock for an aggregate purchase price of approximately $365 million in cash, including an estimated $7 million of Pivotal’s working capital at closing, subject to adjustment based on the post-closing determination of Pivotal’s working capital as set forth in the stock purchase agreement. The Acquisition is expected to close in the second quarter of 2018.
Equity Forward Transaction
On April 11, 2018, the Company effected an equity forward transaction by entering into a forward sale agreement with each of two forward purchasers in connection with a public offering of 2,320,000 shares of the Company’s common stock. In the equity forward transaction, the forward purchasers or an affiliate borrowed an aggregate of 2,320,000 shares of the Company’s common stock from third parties and sold them to the underwriters in the public offering. Except under limited circumstances, the Company has the right under the forward sale agreements to elect physical, net share or cash settlement in whole or in part. If the Company decides to physically settle a forward sale agreement, the Company will issue shares of its common stock to the forward purchaser at the then-applicable forward sale price. The forward sale price is initially $79.36 per share, and is subject to adjustment as specified in each forward sale agreement. The Company must settle the forward sale agreements in full on or before April 11, 2019.
The Company did not receive any proceeds from the sale of its common stock by the underwriters. The Company currently intends to elect full physical settlement of the forward sale agreements by delivering 2,320,000 shares of its Common Stock if the Company successfully completes the Acquisition. The net proceeds of the equity forward transaction are intended to be used to finance a portion of the purchase price of the Acquisition.
Alton, Illinois Wastewater Acquisition
On April 13, 2018, the Company’s Illinois subsidiary entered into an agreement to acquire the City of Alton, Illinois’ regional wastewater system for approximately $54 million. This system currently serves approximately 23,000 customers, including customers in the nearby communities of Bethalto and Godfrey. The closing of this acquisition is subject to approval by the Illinois Public Utility Commission. The Company is expecting this acquisition to close in the first quarter of 2019.

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ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read together with the unaudited Consolidated Financial Statements and the notes thereto included elsewhere in this Form 10-Q. 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-Q should be read as applying to all related forward-looking statements whenever they appear in this Form 10-Q. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as result of a number of factors, including those we discuss under “Forward-Looking Statements,” and elsewhere in this Form 10-Q.
Overview
Through its subsidiaries, American Water Works Company, Inc. is the largest and most geographically diverse, publicly-traded water and wastewater utility company in the United States, as measured by both operating revenue and population served. Our primary business involves the ownership of utilities that provide water and wastewater services to residential, commercial, industrial, public authority, fire service and sale for resale customers, collectively presented as our “Regulated Businesses.” Our utilities are generally subject to economic regulation by certain state utility commissions or other entities engaged in utility regulation, together referred to as Public Utility Commissions (“PUCs” or “Regulators”). We also operate several market-based businesses that are not subject to economic regulation by PUCs, collectively presented as our “Market-Based Businesses.” These businesses provide a broad range of related and complementary water and wastewater services to military bases, municipalities, shale natural gas exploration and production companies, as well as residential, commercial and industrial customers. For further description of our businesses, see Part I, Item 1—Business in our Form 10-K.
You should read the following discussion in conjunction with our Consolidated Financial Statements and related Notes included elsewhere in this Form 10-Q and in our Form 10-K. Throughout this Form 10-Q, unless the context otherwise requires, references to “we”, “us”, “our”, the “Company”, and “American Water” mean American Water Works Company, Inc. and its subsidiaries, taken as a whole.
Quarter Highlights
The following key events and transactions highlighted our first quarter of 2018:
We upsized our revolving credit facility to a maximum of $2.25 billion from $1.75 billion and extended the expiration date to March 2023 from June 2020. We also increased the maximum authorized borrowings under our commercial paper program to $2.10 billion from $1.60 billion.
Our California subsidiary received a decision on its cost of capital filing, authorizing a 9.20% return on equity, an increase in its equity ratio from 53% to 55.39% and approved our requested 5.63% cost of debt.
Fourteen of our regulatory jurisdictions have either opened separate proceedings to address the TCJA, or are planning to incorporate the impacts of the TCJA in existing proceedings, including the state of New Jersey which, effective April 1, 2018, required all utilities to revise interim rates to reflect the new federal corporate income tax rate of 21%. We are working with our regulators to determine the best approach for addressing the TCJA in each of these jurisdictions.
Subsequent to March 31, 2018, the following key events occurred:
On April 11, 2018, American Water Enterprises, LLC (“AWE”), a wholly owned subsidiary of the Company, entered into a purchase agreement to acquire Pivotal Home Solutions, a leading provider of home warranty protection products and services, for approximately $365 million in cash. This transaction is expected to close in the second quarter of 2018 and is intended to be financed with approximately 50% debt and 50% equity. For the equity portion, we entered into forward sale agreements on April 11, 2018. See Note 15—Subsequent Events in the Notes to the Consolidated Financial Statements for additional information.
On April 13, 2018, our Illinois subsidiary entered into an agreement to acquire the City of Alton, Illinois’ regional wastewater system, serving roughly 23,000 customers, for approximately $54 million, with an expected closing in the first quarter of 2019.
On May 2, 2018, the principal issues in our Missouri subsidiary’s general rate case filing were resolved and additional annualized revenues of $33 million were authorized, excluding previously approved infrastructure surcharge revenues and reflecting the TCJA’s reduction in the federal corporate income tax rate. This authorization is not final until a written order is issued.

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Financial Results
For the three months ended March 31, 2018, net income attributable to common stockholders was $0.59 per diluted share, an increase of $0.07 per diluted share, or 13.5% compared to the same period in 2017. This increase was primarily due to continued growth in our Regulated Businesses, largely driven by infrastructure investment, acquisitions and organic growth, combined with growth in our Market-Based Businesses, mainly from our Homeowner Services Group. See “Consolidated Results of Operations” and “Segment Results of Operations” in this section for further discussion.
Focusing on Central Themes
In 2018, our strategy, which is driven by our vision and core values, will continue to be anchored on our five central themes: (i) safety; (ii) customers; (iii) people; (iv) growth; and (v) technology and operational efficiency. We continue to focus on operating our business responsibly and managing our operating and capital costs in a manner that benefits our customers and produces long-term value for our stockholders. Additionally, we continue to execute on our ongoing strategy that ensures a safe workplace for our employees, emphasizes public safety for our customers and communities, and leverages our human resources, processes and technology innovation to make our business more effective and efficient. The progress that we have made during the first three months of 2018 with respect to growth and improvement in our operational efficiency is described below.
Growth—Infrastructure improvements, acquisitions and strategic capital investments
During the first three months of 2018, we made capital investments of approximately $343 million, focused in two key areas:
$335 million, of which the majority was in our Regulated Businesses for infrastructure improvements; and
$8 million to fund acquisitions in our Regulated Businesses, which added approximately 2,500 water and wastewater customers.
For the full year of 2018, our capital investment is expected to be in the range of $1.9 billion to $2.1 billion, including the acquisition of Pivotal, which is expected to close in the second quarter of 2018.
On April 11, 2018, AWE entered into a stock purchase agreement to acquire all of the capital stock of Pivotal from a subsidiary of Southern Company Gas. Pivotal is headquartered in Naperville, Illinois and is a leading provider of home warranty protection products and services, operating in 18 states with approximately 1.2 million customer contracts. Under the terms of the stock purchase agreement, AWE will purchase all of Pivotal’s capital stock for an aggregate purchase price of approximately $365 million, including an estimated $7 million of Pivotal’s working capital at closing, subject to adjustment as set forth in the stock purchase agreement. The completion of the Acquisition is subject to obtaining regulatory consents and approvals and satisfying other customary closing obligations. The Acquisition is expected to close in the second quarter of 2018 and is intended to be financed with approximately 50% debt and 50% equity. See Note 15—Subsequent Events in the Notes to the Consolidated Financial Statements for additional information.
On April 13, 2018, our Illinois subsidiary entered into an agreement to acquire the City of Alton, Illinois’ regional wastewater system for approximately $54 million. This system currently serves approximately 23,000 customers, including customers in the nearby communities of Bethalto and Godfrey. The closing of this acquisition is subject to approval by the Illinois PUC. We are expecting this acquisition to close in the first quarter of 2019.
On September 29, 2017, our Military Services Group was awarded a contract for ownership, operation and maintenance of the water and wastewater systems at Wright-Patterson Air Force Base, the largest single-site employer in the state of Ohio. The contract award includes estimated revenues of approximately $490 million over a 50-year period, subject to an annual economic price adjustment. After successful resolution of a bid protest that had been filed by an unsuccessful bidder in the fourth quarter of 2017, the contract previously awarded to our Military Services Group was reinstated on April 20, 2018.
Technology & Operational Efficiency—Continued improvement in our Regulated Businesses’ adjusted O&M efficiency ratio
Our adjusted O&M efficiency ratio, which we use as a measure of our operating performance, was 35.6% for the twelve months ended March 31, 2018, as compared to 36.6% for the twelve months ended March 31, 2017, with all periods prior to January 1, 2018, presented on a pro forma basis to include the estimated impact of the TCJA on operating revenues. The improvement in this ratio was primarily attributable to an increase in operating revenue our Regulated Businesses.
Our adjusted O&M efficiency ratio is defined as the operation and maintenance expenses from our Regulated Businesses divided by the pro forma operating revenues from our Regulated Businesses, where both operation and maintenance expenses and pro forma operating revenues were adjusted to eliminate purchased water expense. Additionally, from operation and maintenance expenses, we excluded the allocable portion of non-operation and maintenance support services cost, mainly depreciation and general taxes, that are reflected in our Regulated Businesses segment as operation and maintenance expenses, but for consolidated financial reporting purposes, are categorized within other line items in the accompanying Consolidated Statements of Operations.

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In addition to the adjustments discussed above, for period-to-period comparability purposes, we have presented the estimated impact of the TCJA on operating revenues for our Regulated Businesses on a pro forma basis for all periods presented prior to January 1, 2018, as if the lower federal corporate income tax rate was in effect for these periods (see Note 5—Regulatory Liabilities in the Notes to the Consolidated Financial Statements for additional information). We also made the following adjustments to our O&M efficiency ratio: (i) we excluded from operation and maintenance expenses the impact of certain Freedom Industries chemical spill settlement activities recognized in 2016 and 2017; and (ii) we excluded from operation and maintenance expenses the impact of the Company’s January 1, 2018 adoption of Accounting Standard Update 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-Retirement Benefit Cost (“ASU 2017-07”) for 2016, 2017 and 2018 (see Note 2—Significant Accounting Policies in the Notes to the Consolidated Financial Statements for additional information). We excluded the items discussed above from the calculation as we believe such items are not reflective of management’s ability to increase the efficiency of our Regulated Businesses.
We evaluate our operating performance using this ratio because we believe it directly measures improvement in the efficiency of our Regulated Businesses. This information is intended to enhance an investor’s overall understanding of our operating performance. Our adjusted O&M efficiency ratio is not an accounting measure that is based on accounting principles generally accepted in the United States (“GAAP”), 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.

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The following table provides the calculation of our adjusted O&M efficiency ratio and a reconciliation that compares operation and maintenance expenses and operating revenues, each as determined in accordance with GAAP, to those amounts utilized in the calculation of our adjusted O&M efficiency ratio:
 
For the Twelve Months Ended March 31,
(In millions)
2018
 
2017
Total operation and maintenance expenses
$
1,388

 
$
1,493

Less:
 
 
 
Operation and maintenance expenses—Market-Based Businesses
329

 
361

Operation and maintenance expenses—Other
(48
)
 
(44
)
Total operation and maintenance expenses—Regulated Businesses
1,107

 
1,176

Less:
 
 
 
Regulated purchased water expenses
131

 
122

Allocation of non-operation and maintenance expenses
30

 
28

Impact of Freedom Industries settlement activities (a)
(22
)
 
65

Impact of adoption of ASU 2017-07 (b)
6

 
5

Adjusted operation and maintenance expenses—Regulated Businesses (i)
$
962

 
$
956

 
 
 
 
Total operating revenues
$
3,362

 
$
3,315

Less:
 
 
 
Pro forma adjustment for impact of the TCJA (c)
129

 
163

Total pro forma operating revenues
3,233

 
3,152

Less:
 
 
 
Operating revenues—Market-Based Businesses
419

 
440

Operating revenues—Other
(22
)
 
(21
)
Total pro forma operating revenues—Regulated Businesses
2,836

 
2,733

Less:
 
 
 
Regulated purchased water revenues (d)
131

 
122

Adjusted pro forma operating revenues—Regulated Businesses (ii)
$
2,705

 
$
2,611

 
 
 
 
Adjusted O&M efficiency ratio—Regulated Businesses (i) / (ii)
35.6
%
 
36.6
%
NOTE
The adjusted O&M efficiency ratio previously reported for the twelve months ended March 31, 2017 was 34.6%, which did not include the adjustments for the items discussed in footnotes (b) and (c) below.
(a)
Includes the impact of the binding global agreement in principle to settle claims in 2016 and a settlement with one of our general liability insurance carriers in 2017.
(b)
Includes the impact of the Company’s adoption of ASU 2017-07 on January 1, 2018. See Note 2—Significant Accounting Policies in the Notes to the Consolidated Financial Statements for additional information.
(c)
Includes the estimated impact of the TCJA on operating revenues for our Regulated Businesses for all periods presented prior to January 1, 2018, as if the lower federal corporate income tax rate was in effect for these periods. See Note 5—Regulatory Liabilities in the Notes to the Consolidated Financial Statements for additional information.
(d)
The calculation assumes regulated purchased water revenues approximate regulated purchased water expenses.

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Regulatory Matters
The following table provides annualized incremental revenues resulting from rate authorizations that became effective during the three months ended March 31, 2018 for general rate cases and infrastructure surcharges, assuming a constant water sales volume:
(In millions)
For the Three Months Ended March 31, 2018
General rate cases by state:
 

Pennsylvania (effective January 1, 2018)
$
62

Total general rate cases
$
62

 
 
Infrastructure surcharges by state:
 

Indiana (effective March 14, 2018)
$
7

Virginia (effective March 1, 2018)
1

Illinois (effective January 1, 2018)
3

West Virginia (effective January 1, 2018)
3

Total infrastructure surcharges
$
14

On May 2, 2018, the Missouri Public Service Commission (“MoPSC”) voted in open session to approve the stipulations of settlement resolving the principal issues in our Missouri subsidiary’s general rate case. The approved stipulations and settlement include a $33 million revenue requirement increase, excluding previously approved infrastructure surcharge revenues and reflecting the prospective impact of the reduction in federal corporate income tax rate resulting from the TCJA, beginning as of the effective date of the new rates. The MoPSC’s determination is not final until a written order is issued.
On April 10, 2018, our Tennessee subsidiary received a decision on its infrastructure surcharge filing, authorizing additional annualized revenues of $1 million, which includes the impact of the reduction in the federal corporate income tax rate resulting from the TCJA.
On March 22, 2018, our California subsidiary received a decision on its cost of capital filing, authorizing for 2018, a 9.20% return on equity, a 5.63% cost of debt and a capital structure of 44.61% debt and 55.39% equity. The decision also approved continuation of the three-year trigger mechanism tied to the Moody’s Baa utility bond index.
Pending General Rate Case Filings
On April 30, 2018, our West Virginia subsidiary filed a general rate case requesting $29 million in additional annualized water and wastewater revenues, excluding previously authorized infrastructure surcharge revenues.
During the third quarter of 2017, our New Jersey subsidiary filed a general rate case requesting $129 million in additional annualized water and wastewater revenues. On February 8, 2018, this request was reduced to $117 million to reflect the reduction in the federal corporate income tax rate resulting from the TCJA.
During the third quarter of 2016, our California subsidiary filed a general rate case requesting $35 million in additional annualized revenues for 2018 and an increase of $8 million in the escalation year of 2019 and the attrition year of 2020. During the fourth quarter of 2016, an update to this request was filed, reducing the 2018 request to $32 million in additional annualized revenues and increasing the 2019 escalation year request to $9 million. On February 23, 2018, the 2018 request was reduced to $24 million to reflect the reduction in the federal corporate income tax rate resulting from the TCJA, and then further reduced to $19 million on April 6, 2018, to reflect the impact of the recently approved cost of capital decision in the current general rate filing.
There is no assurance that all or any portion of these requests will be granted.

28

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Legislative Updates
During the first quarter of 2018, two of our regulatory jurisdictions enacted fair market value legislation further enabling private sector investment in public sector water and wastewater systems. This legislature includes House File 2307 in Iowa and House Bill 1566 in Maryland, both of which allow a fair market value methodology to be included in rate base with respect to prospective acquisitions. Fair market value assessment of water and wastewater systems is an alternative to the traditional depreciated original cost method of valuation, providing municipalities with a fair and objective purchase price that is reflective of the assets’ value, while increasing a utility’s assurance of recovering its investment over the life of the assets acquired. In addition, Senate Enrolled Act 362 was enacted in Indiana, which, similar to the Water Quality Accountability Act enacted in New Jersey in 2017, sets new operational standards and requirements for water and wastewater treatment plants in areas such as capital asset management, cost-benefit analysis and cybersecurity.
Tax Matters
On December 22, 2017, the TCJA was signed into law, which, among other things, enacted significant and complex changes to the Internal Revenue Code of 1986, including a reduction in the federal corporate income tax rate from 35% to 21% as of January 1, 2018, and certain other provisions related specifically to the public utility industry, including continuation of interest expense deductibility, the exclusion from utilizing bonus depreciation and the normalization of deferred income tax. The enactment of the TCJA required a re-measurement of our deferred income taxes that materially impacted our 2017 results of operations and financial position. The portion of this re-measurement related to our Regulated Businesses was substantially offset by a regulatory liability, as we believe it is probable that the deferred income tax excesses created by the TCJA will benefit our regulated customers in future rates. The remaining portion of this re-measurement of the net deferred income tax liability was recorded as a non-cash charge to earnings during the fourth quarter of 2017.
During the first quarter of 2018, our fourteen regulatory jurisdictions have either opened separate proceedings to address the TCJA, or are planning to incorporate the impacts of the TCJA in existing proceedings, including in the state of New Jersey which, effective April 1, 2018, required all utilities to revise interim rates to reflect the new federal corporate income tax rate of 21%. We are working with each jurisdiction to determine the best approach to pass the benefits from the lower tax rate to our regulated customers, ideally through established ratemaking, tax and regulatory normalization provisions. For the normalization component of deferred taxes, we have proposed tracking mechanisms until the Company is able to obtain more clarity regarding: (i) the technical aspects of the methods available to compute the appropriate amount of deferred income tax excess to normalize, and (ii) the period over which the benefits will be refunded to customers, both of which are expected in 2019. To date, a few jurisdictions have agreed to our proposed delay.
On March 23, 2018, President Trump signed the Consolidated Appropriations Act of 2018 (the “Bill”). The Bill corrects and clarifies some aspects of the TCJA related to bonus depreciation eligibility. Specifically, property that was acquired, or the construction began prior to September 27, 2017, will be eligible for bonus depreciation. This clarification will allow the Company to benefit from additional bonus depreciation deductions resulting in a slight delay of when the Company expects to become a cash taxpayer for federal income tax purposes. We believe that we will likely begin paying federal income taxes towards the beginning of 2020, when we expect our federal NOL carryforwards will be fully realized, and expect to be a full cash taxpayer by 2021, although this timing could be impacted by any significant changes in our future results of operations and the outcome of regulatory proceedings regarding the TCJA.

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Consolidated Results of Operations
The following table presents our consolidated results of operations and the ensuing discussions explain the material variances related to the major components:
 
For the Three Months Ended March 31,
 
2018
 
2017
 
Increase (Decrease)
(In millions)
 
 
 
 
 
 
 
Operating revenues
$
761

 
$
756

 
$
5

 
0.7
 %
Operating expenses:
 
 
 
 
 
 
 
Operation and maintenance
347

 
334

 
13

 
3.9
 %
Depreciation and amortization
129

 
124

 
5

 
4.0
 %
General taxes
70

 
68

 
2

 
2.9
 %
Gain on asset dispositions and purchases
(2
)
 

 
(2
)
 
100.0
 %
Total operating expenses, net
544

 
526

 
18

 
3.4
 %
Operating income
217

 
230

 
(13
)
 
(5.7
)%
Other income (expenses):
 
 
 
 
 
 
 
Interest, net
(84
)
 
(85
)
 
1

 
(1.2
)%
Non-operating benefit costs, net
3

 
(3
)
 
6

 
(200.0
)%
Other, net
4

 
3

 
1

 
33.3
 %
Total other income (expenses)
(77
)
 
(85
)
 
8

 
(9.4
)%
Income before income taxes
140

 
145

 
(5
)
 
(3.4
)%
Provision for income taxes
34

 
52

 
(18
)
 
(34.6
)%
Net income attributable to common stockholders
$
106

 
$
93

 
$
13

 
14.0
 %
Operating Revenues
For the three months ended March 31, 2018, operating revenues increased primarily due to a:
$39 million increase in our Regulated Businesses principally due to authorized rate increases and increases from water and wastewater acquisitions, organic growth and higher water services demand; partially offset by a
$32 million reserve on revenue earned by our Regulated Businesses during the first quarter of 2018, for the estimated income tax savings resulting from the TCJA, which is expected to benefit our customers (a corresponding regulatory liability was recorded); and a
$3 million decrease in our Market-Based Businesses mainly due to lower capital upgrades in our Military Services Group, largely attributable to reduced military base budgets, offset in part by incremental revenues in Keystone Clearwater Solutions, LLC (“Keystone”), our water management solutions subsidiary operating in the Appalachian basin, from an increase in operations as a result of market recovery in the shale natural gas industry.
Operation and Maintenance
For the three months ended March 31, 2018, operation and maintenance expense increased primarily due to a:
$19 million increase in our Regulated Businesses principally due to a higher volume of main breaks experienced in the first quarter of 2018, an increase in production costs and purchased water price and usage increases in our California subsidiary; partially offset by a
$8 million decrease in our Market-Based Businesses mainly due to lower capital upgrades in our Military Services Group, as discussed above, and a decrease in claims expense in our Homeowner Services Group, driven by operational efficiencies gained through improved planning and relationship management of key contractor partnerships.
Depreciation and Amortization
For the three months ended March 31, 2018, depreciation and amortization expense increased primarily due to additional utility plant placed in service.

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Other Income (Expenses)
For the three months ended March 31, 2018, other income (expenses) decreased mainly due to a reduction in interest expense and actuarial losses related to the non-service cost components of pension and other post-retirement benefits expense. The presentation of net periodic benefit costs on the Consolidated Statements of Operations was changed pursuant the adoption and retrospective application of ASU 2017-07 on January 1, 2018. See Note 2—Significant Accounting Policies in the Notes to the Consolidated Financial Statements for additional information.
Provision for Income Taxes
For the three months ended March 31, 2018, our provision for income taxes decreased mainly due to the reduction in the federal corporate income tax rate from 35% to 21% as of January 1, 2018, resulting from the TCJA. In our Regulated Businesses, we expect the reduced tax rate will benefit our customers through established ratemaking, tax and regulatory normalization provisions. In our Military Services Group, we are awaiting guidance on how to apply the TCJA to our contracts with the U.S. government.
Segment Results of Operations
Our segments are determined based on how we assess performance and allocate our resources. We evaluate the performance of our segments and allocate resources based on several factors, with the primary measure being net income attributable to common stockholders. The majority of our business is conducted through our Regulated Businesses reportable segment. We also operate several market-based businesses that provide a broad range of related and complementary water and wastewater services within four operating segments that individually do not meet the criteria of a reportable segment in accordance with GAAP. These four, non-reportable operating segments are collectively presented as our Market-Based Businesses, which is consistent with how management assesses the results of our businesses.
Regulated Businesses Segment
The following table summarizes certain financial information for our Regulated Businesses segment:
 
For the Three Months Ended March 31,
 
2018
 
2017
 
Increase (Decrease)
(In millions)
 
 
 
 
 
 
 
Operating revenues
$
666

 
$
659

 
$
7

 
1.1
 %
Operation and maintenance
278

 
259

 
19

 
7.3
 %
Depreciation and amortization
122

 
117

 
5

 
4.3
 %
Income before income taxes
142

 
154

 
(12
)
 
(7.8
)%
Provision for income taxes
38

 
60

 
(22
)
 
(36.7
)%
Net income attributable to common stockholders
104

 
94

 
10

 
10.6
 %

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Operating Revenues
The following tables summarize information regarding the main components of our Regulated Businesses’ operating revenues and the ensuing discussions explain the material variances related to operating revenues:
 
For the Three Months Ended March 31,
 
2018
 
2017
 
Increase (Decrease)
(In millions)
 
 
 
 
 
 
 
Water services:
 
 
 
 
 
 
 
Residential
$
368

 
$
359

 
$
9

 
2.5
 %
Commercial
133

 
128

 
5

 
3.9
 %
Industrial
31

 
32

 
(1
)
 
(3.1
)%
Public and other
80

 
80

 

 
 %