Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended September 30, 2010

OR

 

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

For the transition period from              to             

Commission file: number 001-34028

 

 

AMERICAN WATER WORKS COMPANY, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   51-0063696

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

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

(856) 346-8200

(Registrant’s telephone number, including area code)

 

 

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

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

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

 

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

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

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

 

Class

 

Outstanding at October 29, 2010

Common Stock, $0.01 par value per share   174,873,174 shares

 

 

 


Table of Contents

 

TABLE OF CONTENTS

AMERICAN WATER WORKS COMPANY, INC.

REPORT ON FORM 10-Q

FOR THE QUARTER ENDED September 30, 2010

INDEX

 

PART I. FINANCIAL INFORMATION

     1   

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

     1-19   

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

     20 - 41   

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     42   

ITEM 4. CONTROLS AND PROCEDURES

     42   

PART II. OTHER INFORMATION

     42   

ITEM 1. LEGAL PROCEEDINGS

     42   

ITEM 1A. RISK FACTORS

     42   

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

     42   

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     42   

ITEM 4. [RESERVED]

     42   

ITEM 5. OTHER INFORMATION

     42   

ITEM 6. EXHIBITS

     43   

SIGNATURES

     44   

EXHIBITS INDEX

     44   

EXHIBIT 10.1

  

EXHIBIT 10.2

  

EXHIBIT 31.1

  

EXHIBIT 31.2

  

EXHIBIT 32.1

  

EXHIBIT 32.2

  

EXHIBIT 101

  

 

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Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

American Water Works Company, Inc. and Subsidiary Companies

Consolidated Balance Sheets (Unaudited)

(In thousands, except per share data)

 

     September 30,
2010
    December 31,
2009
 
ASSETS     

Property, plant and equipment

    

Utility plant—at original cost, net of accumulated depreciation of $3,349,819 at September 30 and $3,168,078 at December 31

   $ 10,872,916      $ 10,523,844   

Nonutility property, net of accumulated depreciation of $133,694 at September 30 and $117,245 at December 31

     140,431        153,549   
                

Total property, plant and equipment

     11,013,347        10,677,393   
                

Current assets

    

Cash and cash equivalents

     23,501        22,256   

Restricted funds

     99,974        41,020   

Utility customer accounts receivable

     201,354        149,417   

Allowance for uncollectible accounts

     (21,182     (19,035

Unbilled utility revenues

     150,927        130,262   

Non-Regulated trade and other receivables, net

     81,671        75,086   

Income taxes receivable

     6,394        17,920   

Materials and supplies

     31,345        29,521   

Other

     53,415        52,680   
                

Total current assets

     627,399        499,127   
                

Regulatory and other long-term assets

    

Regulatory assets

     1,011,554        952,020   

Restricted funds

     26,330        20,212   

Goodwill

     1,250,692        1,250,381   

Other

     54,353        53,518   
                

Total regulatory and other long-term assets

     2,342,929        2,276,131   
                

TOTAL ASSETS

   $ 13,983,675      $ 13,452,651   
                

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

 

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Table of Contents

 

American Water Works Company, Inc. and Subsidiary Companies

Consolidated Balance Sheets (Unaudited)

(In thousands, except per share data)

 

     September 30,
2010
    December 31,
2009
 
CAPITALIZATION AND LIABILITIES     

Capitalization

    

Common stock ($.01 par value, 500,000 shares authorized, 174,860 and 174,630 shares outstanding at September 30 and December 31, respectively)

   $ 1,749      $ 1,746   

Paid-in-capital

     6,151,349        6,140,077   

Accumulated deficit

     (1,960,806     (2,076,287

Accumulated other comprehensive loss

     (61,086     (64,677
                

Common stockholders’ equity

     4,131,206        4,000,859   

Preferred stock without mandatory redemption requirements

     4,547        4,557   
                

Total stockholders’ equity

     4,135,753        4,005,416   
                

Long-term debt

    

Long-term debt

     5,371,548        5,288,180   

Redeemable preferred stock at redemption value

     23,802        23,946   
                

Total capitalization

     9,531,103        9,317,542   
                

Current liabilities

    

Short-term debt

     181,841        119,497   

Current portion of long-term debt

     43,984        54,068   

Accounts payable

     166,388        138,609   

Taxes accrued, including income taxes of $0 at September 30 and $1,777 at December 31

     57,002        45,552   

Interest accrued

     103,119        60,128   

Other

     189,090        189,538   
                

Total current liabilities

     741,424        607,392   
                

Regulatory and other long-term liabilities

    

Advances for construction

     617,147        633,509   

Deferred income taxes

     1,050,293        851,677   

Deferred investment tax credits

     31,415        32,590   

Regulatory liabilities

     337,296        322,281   

Accrued pension expense

     388,876        431,010   

Accrued postretirement benefit expense

     230,214        236,045   

Other

     45,575        47,325   
                

Total regulatory and other long-term liabilities

     2,700,816        2,554,437   
                

Contributions in aid of construction

     1,010,332        973,280   

Commitments and contingencies (See Note 9)

     —          —     
                

TOTAL CAPITALIZATION AND LIABILITIES

   $ 13,983,675      $ 13,452,651   
                

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 and Comprehensive Income (Unaudited)

(In thousands, except per share data)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Operating revenues

   $ 786,946      $ 679,956      $ 2,046,222      $ 1,842,866   
                                

Operating expenses

        

Operation and maintenance

     378,034        340,862        1,053,320        985,861   

Depreciation and amortization

     79,431        74,854        232,156        216,939   

General taxes

     55,316        50,618        164,610        154,814   

(Gain) loss on sale of assets

     210        (784     133        (976

Impairment charge

     0        0        0        450,000   
                                

Total operating expenses, net

     512,991        465,550        1,450,219        1,806,638   
                                

Operating income

     273,955        214,406        596,003        36,228   
                                

Other income (expenses)

        

Interest, net

     (74,858     (74,124     (232,307     (219,791

Allowance for other funds used during construction

     2,586        2,290        7,144        9,208   

Allowance for borrowed funds used during construction

     1,814        1,674        4,465        5,537   

Amortization of debt expense

     (1,285     (2,135     (3,233     (5,158

Other, net

     511        (310     2,508        (605
                                

Total other income (expenses)

     (71,232     (72,605     (221,423     (210,809
                                

Income (loss) before income taxes

     202,723        141,801        374,580        (174,581

Provision for income taxes

     78,609        50,165        146,907        94,873   
                                

Net income (loss)

   $ 124,114      $ 91,636      $ 227,673      $ (269,454
                                

Other comprehensive income, net of tax:

        

Pension plan amortized to periodic benefit cost:

        

Prior service cost, net of tax of $13 and $7 for the three months ended and $38 and $22 for the nine months ended, respectively

     20        11        59        34   

Actuarial loss, net of tax of $698 and $958 for the three months ended and $2,094 and $2,874 for the nine months ended, respectively

     1,092        1,499        3,276        4,496   

Foreign currency translation adjustment

     348        503        256        1,377   
                                

Other comprehensive income

     1,460        2,013        3,591        5,907   
                                

Comprehensive income (loss)

   $ 125,574      $ 93,649      $ 231,264      $ (263,547
                                

Income (loss) per common share:

        

Basic

   $ 0.71      $ 0.52      $ 1.30      $ (1.62
                                

Diluted

   $ 0.71      $ 0.52      $ 1.30      $ (1.62
                                

Average common shares outstanding during the period:

        

Basic

     174,859        174,595        174,785        165,992   
                                

Diluted

     175,062        174,691        174,919        165,992   
                                

Dividends per common share

   $ 0.22      $ 0.21      $ 0.64      $ 0.61   
                                

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 thousands, except per share data)

 

     Nine Months Ended
September 30,
 
     2010     2009  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income (loss)

   $ 227,673      $ (269,454

Adjustments

    

Depreciation and amortization

     232,156        216,939   

Impairment charge

     0        450,000   

Amortization of removal costs net of salvage

     32,225        30,417   

Provision for deferred income taxes

     175,090        104,373   

Amortization of deferred investment tax credits

     (1,175     (1,204

Provision for losses on utility accounts receivable

     16,218        17,791   

Allowance for other funds used during construction

     (7,144     (9,208

Loss (gain) on sale of assets

     133        (976

Pension and non-pension post retirement benefits

     67,007        82,246   

Other, net

     (15,601     (18,025

Changes in assets and liabilities

    

Receivables and unbilled utility revenues

     (93,258     (52,798

Income taxes receivable

     11,526        0   

Other current assets

     (2,559     (25,771

Pension and non-pension post retirement benefit contributions

     (110,739     (90,427

Accounts payable

     (6,548     (9,123

Taxes accrued, including income taxes

     5,716        13,652   

Interest accrued

     42,991        44,451   

Other current liabilities

     13,316        (11,332
                

Net cash provided by operating activities

     587,027        471,551   
                

CASH FLOWS FROM INVESTING ACTIVITIES

    

Capital expenditures

     (522,090     (592,894

Acquisitions

     (1,670     (650

Proceeds from sale of assets and securities

     150        1,127   

Removal costs from property, plant and equipment retirements, net

     (28,270     (20,167

Net restricted funds released

     45,928        87,623   

Other

     0        (1,250
                

Net cash used in investing activities

     (505,952     (526,211
                

CASH FLOWS FROM FINANCING ACTIVITIES

    

Proceeds from long-term debt

     162,541        336,994   

Repayment of long-term debt

     (196,449     (176,032

Net borrowings (repayments) under short-term debt agreements

     78,998        (223,375

Proceeds from issuance of common stock (net of 2009 expenses of $7,824)

     0        242,301   

Proceeds from employee stock plan issuances and DRIP

     3,823        1,583   

Advances and contributions for construction, net of refunds of $28,775 and $20,041 at September 30, 2010 and 2009

     4,975        13,349   

Change in cash overdraft position

     (16,654     (34,354

Debt issuance costs

     (5,089     (6,713

Redemption of preferred stock

     (150     (140

Dividends paid

     (111,825     (100,664
                

Net cash (used in) provided by financing activities

     (79,830     52,949   
                

Net increase (decrease) in cash and cash equivalents

     1,245        (1,711

Cash and cash equivalents at beginning of period

     22,256        9,542   
                

Cash and cash equivalents at end of period

   $ 23,501      $ 7,831   
                

Non-cash investing activity:

    

Capital expenditures acquired on account but unpaid at quarter-end

   $ 96,383      $ 51,267   

Non-cash financing activity:

    

Long-term debt

   $ 111,000      $ 151,431   

Advances and contributions

   $ 21,474      $ 64,383   

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 Statement of Changes in Stockholders’ Equity (Unaudited)

(In thousands, except per share data)

 

     Common Stock      Paid-in
Capital
     Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss
    Treasury Stock    

Preferred

Stock

of

Subsidiary

Companies

Without

Mandatory

    Total
Stockholders’
Equity
 
   Shares      Par
Value
            Shares      At Cost     Redemption
Requirements
   

Balance at December 31, 2009

     174,630       $ 1,746       $ 6,140,077       $ (2,076,287   $ (64,677     0       $ 0      $ 4,557      $ 4,005,416   

Net income

     —           —           —           227,673        —          —           —          —          227,673   

Stock-based compensation and DRIP activity, net of expenses of $69

     230         3         11,272         (367     —          0         0        —          10,908   

Preferred stock redemption

     —           —           —           —          —          —           —          (10     (10

Other comprehensive income, net of tax of $2,132

     —           —           —           —          3,591        —           —          —          3,591   

Dividends

     —           —           —           (111,825     —          —           —          —          (111,825
                                                                            

Balance at September 30, 2010

     174,860       $ 1,749       $ 6,151,349       $ (1,960,806   $ (61,086     0       $ 0      $ 4,547      $ 4,135,753   
                                                                            

Balance at December 31, 2008

     160,000       $ 1,600       $ 5,888,253       $ (1,705,594   $ (82,251     0       $ (7   $ 4,557      $ 4,106,558   

Net loss

     —           —           —           (269,454     —          —           —          —          (269,454

Common stock offering, net of expenses of $7,824

     14,500         145         242,156         —          —          —           —          —          242,301   

Stock-based compensation activity

     100         1         7,362         (208     —          0         6        —          7,161   

Other comprehensive income, net of tax of $2,896

     —           —           —           —          5,907        —           —          —          5,907   

Dividends

     —           —           —           (100,664     —          —           —          —          (100,664
                                                                            

Balance at September 30, 2009

     174,600       $ 1,746       $ 6,137,771       $ (2,075,920   $ (76,344     0       $ (1   $ 4,557      $ 3,991,809   
                                                                            

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)

(In thousands, except per share data)

Note 1: Basis of Presentation

The accompanying Consolidated Balance Sheet of American Water Works Company, Inc. and Subsidiary Companies (the “Company”) at September 30, 2010, the Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended September 30, 2010 and 2009, the Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009, and the Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2010 and 2009, are unaudited, but reflect all adjustments, which are, in the opinion of management, necessary to present fairly the consolidated financial position, the consolidated changes in stockholders’ equity, the consolidated results of operations and comprehensive income, and the consolidated cash flows for the periods presented. All adjustments are of a normal, recurring nature, except as otherwise disclosed. Because they cover interim periods, the unaudited consolidated financial statements and related notes to the consolidated financial statements do not include all disclosures and notes normally provided in annual financial statements and, therefore, should be read in conjunction with the Company’s Consolidated Financial Statements and related Notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the year, due primarily to the seasonality of the Company’s operations.

Note 2: New Accounting Pronouncements

Fair Value Measurements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance that requires new disclosures of (i) the amounts of significant transfers into and out of Level 1 and Level 2 of the fair value hierarchy and the reasons for those transfers and (ii) information in the reconciliation of recurring Level 3 measurements (those using significant unobservable inputs) about purchases, sales, issuances, and settlements on a gross basis. This update also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. This guidance is effective for interim and annual periods beginning after December 15, 2009, except for the requirement to disclose information about purchases, sales, issuances and settlements in the reconciliation of Level 3 measurements, which does not become effective until interim and annual periods beginning after December 15, 2010. As this guidance clarifies and provides for additional disclosure requirements only, the adoption of this guidance does not have an impact on the Company’s results of operations, financial position or cash flows.

Consolidation of Variable Interest Entities

In June 2009, the FASB issued authoritative guidance that replaces the quantitative-based risk and rewards calculation for determining which reporting entity has a controlling financial interest in a variable interest entity with a qualitative approach. This revised guidance also requires additional disclosures about a reporting entity’s involvement in variable interest entities. This guidance is effective for the Company beginning January 1, 2010. These changes did not have an impact on the Company’s results of operations, financial position or cash flows; however, these changes could impact the accounting for the Company’s interests in a variable interest entity in the future.

Note 3: Goodwill

At September 30, 2010 the Company’s goodwill totaled $1,250,692. The Company’s annual goodwill impairment test is conducted at November 30 of each calendar year and interim reviews are performed when the Company determines that a triggering event that would more likely than not reduce the fair value of a reporting unit below its carrying value has occurred. The Company concluded no such triggering event occurred during the nine months ended September 30, 2010. Accordingly, no interim review was performed for this period.

During the first quarter of 2009, the Company’s stock price experienced a high degree of volatility and, as of March 31, 2009, had a sustained period for which it was below historical averages and 10% below the market price employed in the Company’s 2008 annual goodwill impairment test. Having considered both qualitative and quantitative factors, management concluded that this sustained decline in market value below the market value that existed at the 2008 annual impairment test was an interim triggering event and performed an interim impairment test. The Company’s calculated market capitalization at March 31, 2009 was $1,186,000 below its aggregated carrying value of its reporting units.

Management concluded the fair value of certain of the Company’s reporting units were below their carrying values as of March 31, 2009. Upon completing the impairment calculation, the Company recognized $450,000 as a goodwill impairment charge for the three months ended March 31, 2009.

 

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The following table summarizes the nine-month changes in the Company’s goodwill by reporting unit:

 

     Regulated Unit     Non-Regulated Units     Consolidated  
     Cost      Accumulated
Impairment
    Cost      Accumulated
Impairment
    Cost      Accumulated
Impairment
    Total Net  

Balance at January 1, 2010

   $ 3,565,913       $ (2,443,628   $ 235,715       $ (107,619   $ 3,801,628       $ (2,551,247   $ 1,250,381   

Reclassifications and other activity

     36         0        275         0        311         0        311   
                                                           

Balance at September 30, 2010

   $ 3,565,949       $ (2,443,628   $ 235,990       $ (107,619   $ 3,801,939       $ (2,551,247   $ 1,250,692   
                                                           

Balance at January 1, 2009

   $ 3,565,215       $ (1,995,380   $ 235,549       $ (105,867   $ 3,800,764       $ (2,101,247   $ 1,699,517   

Impairment losses

     0         (448,248     0         (1,752     0         (450,000     (450,000

Reclassifications and other activity

     550         0        0         0        550         0        550   
                                                           

Balance at September 30, 2009

   $ 3,565,765       $ (2,443,628   $ 235,549       $ (107,619   $ 3,801,314       $ (2,551,247   $ 1,250,067   
                                                           

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

The Company uses a two-step impairment test to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized (if any). The step 1 calculation used to identify potential impairment compares the calculated fair value for each of the Company’s reporting units to their respective net carrying values (book values), including goodwill, on the measurement date. If the fair value of any reporting unit is less than such reporting unit’s carrying value, then step 2 is performed to measure the amount of the impairment loss (if any) for such reporting unit.

The step 2 calculation of the impairment test compares, by reporting unit, the implied fair value of the goodwill to the carrying value of goodwill. The implied fair value of goodwill is equal to the excess of the fair value of each reporting unit above the fair value of such reporting unit’s identified assets and liabilities. If the carrying value of goodwill exceeds the implied fair value of goodwill for any reporting unit, an impairment loss is recognized in an amount equal to the excess (not to exceed the carrying value of goodwill) for that reporting unit.

The determination of the fair value of each reporting unit and the fair value of each reporting unit’s assets and liabilities is performed as of the measurement date using observable market data before and after the measurement date (if that subsequent information is relevant to the fair value on the measurement date).

The estimated fair value of the Regulated reporting unit for step 1 is based on a combination of the following valuation techniques:

 

   

observable trading prices of comparable equity securities of publicly-traded water utilities considered by us to be the Company’s peers; and

 

   

discounted cash flow models developed from the Company’s internal forecasts.

The estimated fair values of the Non-Regulated reporting units are determined entirely on the basis of discounted cash flow models.

The first valuation technique applies average peer multiples to the Regulated reporting unit’s historic and forecasted cash flows. The peer multiples are calculated using the average trading prices of comparable equity securities of publicly-traded water utilities, their published cash flows and forecasts of market price and cash flows for those peers.

The second valuation technique forecasts each reporting unit’s five-year cash flows using an estimated long-term growth rate and discounts these cash flows at their respective estimated weighted average cost of capital.

In conjunction with step 1, the Company also reconciles the difference between the calculated market capitalization and the aggregate carrying value of the reporting units to ensure that any excess is supportable by relevant market information. The Company makes certain assumptions, which it believes to be appropriate, that support this reconciliation. The Company considers, in addition to the listed trading price of the Company’s shares, the applicability of a control premium to the Company’s shares and certain other factors the Company deems appropriate. As a result, the Company may conclude that the Company’s fair value exceeds what the Company might otherwise have concluded had it relied on market price alone.

In addition, given recent market conditions, management determined that it is appropriate for the Company to consider the average of the Company’s closing market price over a thirty day period rather than using a particular date to calculate its market capitalization.

 

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If step 2 of the impairment test is required, the Company determines the fair value of the applicable reporting unit’s assets and liabilities. The fair values of the applicable debt are highly dependent upon market conditions surrounding the measurement date. For the step 2 calculations of the fair value of debt, the Company uses observable prices of instruments and indices that have risks similar to those instruments being valued, adjusted to compensate for differences in credit profile, collateral, tax treatment and call features, to calculate the fair value of each reporting unit’s debt.

Note 4: Stockholders’ Equity

Common Stock

On March 23, 2010, the Company filed a Form S-3 Registration Statement with the SEC to register 5,000 shares of the Company’s common stock issuable under American Water Stock Direct, a dividend reinvestment and direct stock purchase plan (the “DRIP”). Under the DRIP, stockholders may reinvest cash dividends and purchase additional Company common stock, up to certain limits, through a transfer agent without commission fees. The Company’s transfer agent may buy newly issued shares directly from the Company or shares held in the Company’s treasury. The transfer agent may also buy shares in the public markets or in privately negotiated transactions. Purchases generally will be made and credited to DRIP accounts once each week. The Company issued 40 shares of common stock with proceeds of $869 during the first nine months of 2010 under the DRIP.

In March and June 2010, the Company made a cash dividend payment of $0.21 per share to all common shareholders of record as of February 18, 2010 and May 18, 2010, amounting to $36,679 and $36,689, respectively. In September 2010, the Company made a cash dividend payment of $0.22 per share to all common shareholders of record as of August 18, 2010, amounting to $38,457.

In March 2009 and June 2009, the Company made a cash dividend payment of $0.20 per share to all common shareholders of record as of February 18, 2009 and May 18, 2009, amounting to $32,000 and $32,006, respectively. In September 2009, the Company made a cash dividend payment of $0.21 per share to all common shareholders of record as of August 18, 2009, amounting to $36,658.

On October 29, 2010, the Company declared a quarterly cash dividend payment of $0.22 per share payable on December 1, 2010 to all shareholders of record as of November 18, 2010.

Stock Based Compensation

The Company has granted stock option and restricted stock unit awards to non-employee directors, officers and other key employees of the Company pursuant to the terms of its 2007 Omnibus Equity Compensation Plan (the “Plan”). As of September 30, 2010, a total of 11,723 shares are available for grant under the Plan. Shares issued under the Plan may be authorized but unissued shares of Company stock or reacquired shares of Company stock, including shares purchased by the Company on the open market for purposes of the Plan.

The Company recognizes compensation expense for stock awards over the vesting period of the award. The following table presents stock-based compensation expense recorded in operations and maintenance expense in the accompanying Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Stock options

   $ 1,323      $ 705      $ 3,177      $ 2,536   

Restricted stock units

     1,551        746        4,437        2,942   

Employee stock purchase plan

     94        97        265        307   
                                

Stock-based compensation in operation and maintenance expense

     2,968        1,548        7,879        5,785   

Income tax benefit

     (1,157     (604     (3,073     (2,257
                                

After-tax stock-based compensation expense

   $ 1,811      $ 944      $ 4,806      $ 3,528   
                                

There were no significant stock-based compensation costs capitalized during the nine months ended September 30, 2010 and 2009, respectively.

 

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Stock Options

Stock options granted in 2008 included 1,470 stock options that were subject to performance-based vesting requirements. In February 2009, the Company cancelled 311 of these stock options related to the first performance vesting period because the performance goals were not fully met at December 31, 2008. In February 2010, the Company cancelled 459 of these stock options related to the second performance vesting period because the second performance goals were not fully met at December 31, 2009. The Company continues to recognize expense on the remaining stock options during the service period, which ends December 31, 2010.

In the first quarter of 2010, the Company granted 867 non-qualified stock options to certain employees under the Plan. The stock options vest ratably over a three-year service period from January 1, 2010. These awards have no performance vesting conditions and the grant date fair value is amortized through expense over the requisite service period using the straight-line method.

On August 15, 2010, the Company’s Board of Directors elected a new President and Chief Executive Officer (“CEO”) of the Company. In connection with his election to these offices, the Company’s new CEO was granted 25 non-qualified stock options that cliff vest two years from the date of grant. Additionally, he was granted 53 non-qualified stock options that vest ratably over a three-year period beginning January 1, 2010. These awards have no performance vesting conditions and the grant date fair value is amortized through expense over the requisite service period using the straight-line method.

Also on August 15, 2010, the Company’s former President and Chief Executive Officer resigned as an officer and director of the Company. Pursuant to his resignation, the Company cancelled options to purchase 33 shares of Company stock, accelerated the vesting of 247 options, extended the termination dates of vested options and recognized additional expense related to the modifications that is recorded in operations and maintenance expense in the accompanying Consolidated Statements of Operations for the three and nine months ended September 30, 2010.

The following table presents the weighted average assumptions used in the pricing model for 2010 grants and the resulting weighted average grant date fair value of stock options granted:

 

Dividend yield

     3.83 

Expected volatility

     31.77 

Risk-free interest rate

     2.14 

Expected life (years)

     4.29   

Exercise price

   $ 22.01   

Grant date fair value

   $ 4.33   

Stock options granted under the Plan have maximum terms of seven years, vest over periods ranging from one to three years, and are granted with exercise prices equal to the market value of the Company’s common stock on the date of grant. As of September 30, 2010, $4,166 of total unrecognized compensation cost related to the non-vested stock options is expected to be recognized over the weighted-average period of 1.4 years. The following table summarizes stock option activity for the nine months ended September 30, 2010:

 

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

Options outstanding at January 1, 2010

     2,724      $ 21.19         

Granted

     945        22.01         

Cancelled

     (459     21.50         

Forfeited or expired

     (135     21.48         

Exercised

     (64     21.33         
                

Options outstanding at September 30, 2010

     3,011      $ 21.39         5.00       $ 5,675   
                                  

Exercisable at September 30, 2010 (a)

     1,048      $ 21.23         4.27       $ 2,135   
                                  

 

(a) Includes stock options issued to retired employees

Cash received for stock options exercised during the nine months ended September 30, 2010 was $1,230 and the intrinsic value of the options was $52.

Restricted Stock Units

Restricted stock units granted in 2008 included 190 restricted stock units that were subject to performance-based vesting requirements. In February 2009, the Company cancelled 39 of these restricted stock units related to the first performance vesting period because the performance goals were not fully met at December 31, 2008. In February 2010, the Company cancelled 60 of these restricted stock units related to the second performance vesting period because the second performance goals were not fully met at December 31, 2009. The Company continues to recognize expense on the remaining restricted stock units during the service period, which ends December 31, 2010.

 

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In the first quarter of 2010, the Company granted 243 restricted stock units to certain employees under the Plan. The restricted stock units vest ratably over the three year performance period beginning January 1, 2010 (the “Performance Period”); however, distribution of the shares is contingent upon the achievement of internal performance measures and, separately, certain market thresholds over the Performance Period. The restricted stock units granted with performance and service conditions are valued at the market value of the Company’s common stock on the date of grant. The restricted stock units granted with market and service conditions are valued using a Monte Carlo model.

On May 7, 2010, the Company granted 19 restricted stock units to non-employee directors under the Plan. The restricted stock units vested on the date of grant; however, distribution of the shares will be made within 30 days of the earlier of August 11, 2011 or the participant’s separation from service. The grant date fair value of these restricted stock units was $20.71.

On August 27, 2010, the Company’s new CEO was granted 12 restricted stock units that vest over the period beginning August 27, 2010 and ending December 31, 2010; however, distribution of the shares is contingent upon the achievement of internal performance measures and, separately, certain market thresholds over the vesting period. The restricted stock units granted with performance and service conditions are valued at the market value of the Company’s common stock on the date of grant. The restricted stock units granted with market and service conditions are valued using a Monte Carlo model.

Also in August 2010, the Company accelerated the vesting of 12 restricted stock units granted in 2008 to the Company’s former CEO. Additionally the Company cancelled 9 restricted stock units granted in 2009 and 2010, the remaining outstanding awards will be subject to the Company’s achievement of internal performance measures and certain market thresholds over the applicable three-year performance periods as if he had remained in the employ of the Company during the entire performance periods. The Company recognized additional expense related to the modifications that is recorded in operations and maintenance expense in the accompanying Consolidated Statements of Operations for the three and nine months ended September 30, 2010.

On September 24, 2010, the Company granted 6 restricted stock units to non-employee directors under the Plan. The restricted stock units vested on the date of grant; however, distribution of the shares will be made within 30 days of the earlier of October 15, 2011 or the participant’s separation from service. The grant date fair value of these restricted stock units was $23.49.

The value of restricted stock awards at the date of the grant is amortized through expense over the requisite service period using the straight-line method for the restricted stock units with service and/or performance vesting. The grant date fair value of the restricted stock awards that have (a) market and/or performance and service conditions and (b) vest ratably is amortized through expense over the requisite service period using the graded-vesting method. As of September 30, 2010, $3,474 of total unrecognized compensation cost related to the non-vested restricted stock units is expected to be recognized over the weighted-average remaining life of 0.8 years.

The following table summarizes restricted stock unit activity for the nine months ended September 30, 2010:

 

     Shares     Weighted Average
Grant Date
Fair Value
(per share)
 

Nonvested total at January 1, 2010

     402      $ 21.77   

Granted

     280        23.23   

Distributed

     (55     20.68   

Cancelled

     (60     21.50   

Forfeited

     (26     23.03   

Undistributed vested awards

     (46     22.45   
          

Nonvested total at September 30, 2010

     495      $ 22.62   
          

The aggregate intrinsic value of restricted stock units distributed during the nine months ended September 30, 2010 was $1,179, on which the Company recognized an income tax benefit of $14 which has been recorded in the accompanying Consolidated Balance Sheets.

If dividends are declared with respect to shares of the Company’s common stock before the restricted stock units are distributed, the Company credits a liability for the value of the dividends that would have been paid if the restricted stock units were shares of Company common stock. When the restricted stock units are distributed, the Company pays the employee a lump sum cash payment equal to the value of the dividend equivalents accrued. The Company accrued dividend equivalents totaling $367 and $208 to retained earnings during the nine months ended September 30, 2010 and 2009, respectively.

Employee Stock Purchase Plan

Under the Nonqualified Employee Stock Purchase Plan (the “ESPP”), employees can use payroll deductions to acquire Company stock at the lesser of 90% of the fair market value of (a) the beginning or (b) the end of each three-month purchase period. As of September 30, 2010 there were 1,740 shares of common stock reserved for issuance under the ESPP. During the nine months ended September 30, 2010, the Company issued 92 shares under the ESPP.

 

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Note 5: Long-Term Debt

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

 

     Rate     Weighted
Average Rate
    Maturity
Date
     September 30,
2010
     December 31,
2009
 

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

            

Private activity bonds and government funded debt(a)

            

Fixed rate

     4.85%-6.75     5.72     2018-2040       $ 322,610       $ 200,975   

Senior notes

            

Fixed rate

     5.39%-10.00     6.26     2011-2039         3,087,701         3,115,853   

Long-term debt of other subsidiaries

            

Private activity bonds and government funded debt

            

Fixed rate

     0.00%-6.20     4.53     2011-2039         1,192,003         1,197,611   

Floating rate(b)

     0.85%-1.05     0.91     2015         8,560         8,560   

Mortgage bonds

            

Fixed rate

     5.48%-9.71     7.48     2011-2039         744,736         754,966   

Mandatory redeemable preferred stock

     4.60%-9.75     8.39     2013-2036         24,067         24,207   

Notes payable and other(c)

     4.90%-14.57     7.50     2011-2026         6,008         6,561   
                        

Long-term debt

            5,385,685         5,308,733   

Unamortized debt discount, net(d)

            50,114         57,461   

Fair value adjustment to interest rate hedge

            3,535         0   
                        

Total long-term debt

          $ 5,439,334       $ 5,366,194   
                        

 

(a) As of December 31, 2009, the Company held $10,635 of floating rate debt in its treasury, as it had not been able to re-issue the debt to investors at acceptable interest rates. On July 27, 2010, the Company re-issued this debt as fixed rate of 5.25% due 2028.
(b) Represents variable rate tax-exempt bonds remarketed for periods up to 270 days. The $8,560 balance is classified as current portion of long-term debt in the accompanying Consolidated Balance Sheets because it was repurchased by the Company during the first quarter of 2009 when no investor was willing to purchase it at market rates. This debt was subsequently remarketed as floating rate debt in the second quarter of 2009.
(c) Includes capital lease obligations of $5,230 and $5,679 at September 30, 2010 and December 31, 2009, respectively.
(d) Includes fair value adjustments previously recognized in acquisition purchase accounting.

The following long-term debt was issued in 2010:

 

Company

  

Type

   Interest Rate     Maturity      Amount  

American Water Capital Corp. (1)

   Private activity bonds and government funded debt – fixed rate      4.85%-5.38     2028-2040       $ 121,635   

Other subsidiaries

   Private activity bonds and government funded debt – fixed rate      0.00%-5.60     2021-2034         151,906   
                

Total issuances

           $ 273,541   
                

 

(1) Includes $111,000 of proceeds from issuances which are initially kept in Trust, pending the Company’s certification that it has incurred qualifying capital expenditures. These issuances have been presented as a non-cash financing activity on the accompanying Consolidated Statements of Cash Flows. Subsequent release of all or a lesser portion of these funds by the applicable Trust are reflected as the release of restricted funds, and are included in investing activities in the accompanying Consolidated Statement of Cash Flows.

The following long-term debt was retired through optional redemption or payment at maturity during 2010:

 

Company

  

Type

   Interest Rate     Maturity      Amount  

American Water Capital Corp.

   Senior notes-fixed rate      6.00%-6.87     2011-2039       $ 28,152   

Other subsidiaries

   Private activity bonds and government funded debt-fixed rate      0.00%-6.88     2010-2036         157,514   

Other subsidiaries

   Mortgage bond      7.86%-8.98     2010-2011         10,230   

Other subsidiaries

   Mandatory redeemable preferred stock      4.60%-6.00     2013-2019         140   

Other

   Capital leases & other           553   
                

Total retirements & redemptions

           $ 196,589   
                

 

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Interest, net includes interest income of approximately $2,531 and $7,450 for the three and nine months ended September 30, 2010, respectively, and $2,404 and $7,366 for the three and nine months ended September 30, 2009, respectively.

On July 12, 2010, the Company entered into an interest rate swap to hedge $100,000 of its 6.085% fixed rate debt maturing 2017. The Company will pay variable interest of six-month LIBOR plus 3.422%. The Company uses a combination of fixed-rate and variable-rate debt to manage interest rate exposure.

At September 30, 2010 and December 31, 2009, the Company had a $100,000 and $0 notional amount variable interest rate swap fair value hedge outstanding, respectively. The following table provides a summary of the derivative fair value balance recorded by the Company as of September 30, 2010 and the line item in the Consolidated Balance Sheet in which such amount is recorded:

 

      September 30,
2010
     December 31,
2009
 

Balance sheet classification

     

Regulatory and other long-term assets

     

Other

   $ 3,228       $ 0   

Long-term debt

     

Long-term debt

   $ 3,535       $ 0   

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

 

     Gain (Loss) on Swap      Gain (Loss) on Borrowings     Hedge
Ineffectiveness
 

Income Statement Classification

   Three Months Ended
September 30, 2010
     Three Months Ended
September 30, 2010
    Three Months Ended
September 30, 2010
 

Interest, net

   $ 3,228       $ (3,535   $ (307
     Gain (Loss) on Swap      Gain (Loss) on Borrowings     Hedge
Ineffectiveness
 

Income Statement Classification

   Nine Months Ended
September 30, 2010
     Nine Months Ended
September 30, 2010
    Nine Months Ended
September 30, 2010
 

Interest, net

   $ 3,228       $ (3,535   $ (307

On November 1, 2010, a regulated subsidiary of the Company closed on a refinancing of two bond issues of $35,000 and $40,000 with maturity dates in 2029 and 2025 and interest rates of 4.88% and 4.70%, respectively.

Note 6: Short-Term Debt

The components of short-term debt are as follows:

 

     September 30,
2010
     December 31,
2009
 

Commercial paper, net of $7 and $5 discount, respectively

   $ 163,993       $ 84,995   

Bank overdraft

     17,848         34,502   
                 

Total short-term debt

   $ 181,841       $ 119,497   
                 

 

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The Company had no outstanding borrowings on its revolving credit line as of September 30, 2010 and December 31, 2009, respectively.

Note 7: Income Taxes

The Company’s estimated annual effective tax rate for the nine months ended September 30, 2010 was 39.7% compared to 39.6% for the nine months ended September 30, 2009, excluding various discrete items including goodwill impairment. The Company’s actual effective tax rates for the three months ended September 30, 2010 and 2009 were 38.8% and 35.4%, respectively. The Company’s actual effective rates for the nine months ended September 30, 2010 and 2009 were 39.2% and (54.3%), respectively.

The 2009 nine month rate reflects the tax effects of goodwill impairments as discrete items as the Company considers these charges as infrequently occurring or unusual.

The Patient Protection and Affordable Care Act (the “PPACA”) became law on March 23, 2010, and the Health Care and Education Reconciliation Act of 2010 became law on March 30, 2010, which makes various amendments to certain aspects of the PPACA (together, the “Acts”). The PPACA effectively changes the tax treatment of federal subsidies paid to sponsors of retiree health benefit plans that provide a benefit that is at least actuarially equivalent to the benefits under Medicare Part D. As a result of the Acts, these subsidy payments will effectively become taxable in tax years beginning after December 31, 2012.

Although this change does not take effect immediately, companies are required to recognize the full accounting impact in their financial statements in the period in which the legislation was enacted. As a result, in the first quarter of 2010, the Company followed its original accounting for the underfunded status of other postretirement benefits for the Medicare Part D adjustment and recorded a reduction in its deferred tax assets and an increase in its regulatory assets amounting to $27,128.

Note 8: Pension and Other Postretirement Benefits

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

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Components of net periodic pension benefit cost

        

Service cost

   $ 7,669      $ 7,107      $ 23,006      $ 21,320   

Interest cost

     16,901        15,730        50,702        47,189   

Expected return on plan assets

     (14,189     (10,556     (42,564     (31,668

Amortization of:

        

Prior service cost

     81        45        242        136   

Actuarial loss

     4,476        5,992        13,427        17,976   
                                

Net periodic pension benefit cost

   $ 14,938      $ 18,318      $ 44,813      $ 54,953   
                                

Components of net periodic other postretirement benefit cost

        

Service cost

   $ 3,665      $ 3,293      $ 10,997      $ 9,879   

Interest cost

     8,037        7,295        24,112        21,885   

Expected return on plan assets

     (6,093     (4,659     (18,279     (13,978

Amortization of:

        

Transition obligation

     43        43        130        130   

Prior service (credit) cost

     (295     (296     (885     (886

Actuarial loss

     2,040        2,289        6,119        6,866   
                                

Net periodic other postretirement benefit cost

   $ 7,397      $ 7,965      $ 22,194      $ 23,896   
                                

The Company contributed $81,700 to its defined benefit pension plan in the first nine months of 2010. In October, the Company contributed $14,900 completing 2010 contributions. In addition, the Company contributed $29,039 for the funding of its other postretirement plans in the first nine months of 2010 and expects to contribute $9,680 during the balance of 2010.

Note 9: Commitments and Contingencies

The Company is also routinely involved in legal actions incident to the normal conduct of its business. At September 30, 2010, the Company has accrued approximately $4,300 as probable costs and it is reasonably possible that additional losses could range up to $12,900 for these matters. For certain matters, the Company is unable to estimate possible losses. The Company believes that damages or settlements, if any, recovered by plaintiffs in such claims or actions will not have a material adverse effect on the Company’s results of operations, financial position or cash flows.

 

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The Company enters into agreements for the provision of services to water and wastewater facilities for the United States military, municipalities and other customers. The Company’s military services agreements expire between 2051 and 2060 and have remaining performance commitments as measured by estimated remaining contract revenue of $2,104,000 at September 30, 2010. The Company’s Operations and Maintenance agreements with municipalities and other customers expire between 2010 and 2048 and have remaining performance commitments as measured by estimated remaining contract revenue of $1,243,000 at September 30, 2010. Some of the Company’s long-term contracts to operate and maintain a municipality’s, federal government’s or other party’s water or wastewater treatment and delivery facilities include responsibility for certain major maintenance for some of those facilities, in exchange for an annual fee. Unless specifically required to perform certain maintenance activities, the maintenance costs are recognized when the maintenance is performed.

Note 10: Environmental Matters

The Company’s water and wastewater operations are subject to federal, state, local and foreign requirements relating to environmental protection and as such the Company periodically becomes subject to environmental claims in the normal course of business. Remediation costs that relate to an existing condition caused by past operations are accrued when it is probable that these costs will be incurred and can be reasonably estimated. Remediation costs accrued amounted to $6,730 and $7,947 at September 30, 2010 and December 31, 2009, respectively. Included in the balance of the accrual was $6,600 at September 30, 2010 and $7,700 at December 31, 2009 related to a conservation agreement entered into by a subsidiary of the Company with the National Oceanic and Atmospheric Administration (“NOAA”) requiring the Company to, among other provisions, implement certain measures to protect the steelhead trout and its habitat in the Carmel River watershed in the state of California. The Company has agreed to pay $1,100 annually from 2010 through 2016; the 2010 payment was made in June. The payments will be used to improve habitat conditions for the steelhead trout in the Carmel River Watershed and will end upon a regional desalinization plant becoming operational and the subsidiary’s diversions from the Carmel River coming within permitted limits. The Company pursues recovery of incurred costs through all appropriate means, including regulatory recovery through customer rates. The Company’s Regulatory assets at September 30, 2010 include $11,026 related to the NOAA agreement, including an additional $3,500 granted for recovery during the three months ended September 30, 2010.

Note 11: Net Income (Loss) per Common Share

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

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

Basic

           

Net income (loss)

   $ 124,114       $ 91,636       $ 227,673       $ (269,454

Less: Distributed earnings to common shareholders (a)

     38,580         36,719         112,155         100,865   

Less: Distributed earnings to participating securities

     13         4         36         0   
                                   

Undistributed earnings

     85,521         54,913         115,482         (370,319

Undistributed earnings allocated to common shareholders (b)

     85,491         54,907         115,444         (370,319

Undistributed earnings allocated to participating securities

     30         6         38         0   
                                   

Total income (loss) available to common shareholders, basic (a) + (b)

   $ 124,071       $ 91,626       $ 227,599       $ (269,454
                                   

Weighted average common shares outstanding, basic

     174,859         174,595         174,785         165,992   
                                   

Basic net income (loss) per common share

   $ 0.71       $ 0.52       $ 1.30       $ (1.62
                                   

 

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

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

Diluted

           

Total income (loss) available to common shareholders, basic

   $ 124,071       $ 91,626       $ 227,599       $ (269,454

Undistributed earnings allocated to participating securities

     30         6         38         0   
                                   

Total income (loss) available to common shareholders, diluted

   $ 124,101       $ 91,632       $ 227,637       $ (269,454
                                   

Weighted average common shares outstanding, basic

     174,859         174,595         174,785         165,992   

Stock-based compensation:

           

Restricted stock units

     183         92         128         0   

Stock options

     18         0         5         0   

Employee stock purchase plan

     2         4         1         0   
                                   

Weighted average common shares outstanding, diluted

     175,062         174,691         174,919         165,992   
                                   

Diluted net income (loss) per commons share

   $ 0.71       $ 0.52       $ 1.30       $ (1.62
                                   

Options to purchase 1,873 and 2,122 shares of the Company’s common stock were excluded from the calculation of diluted common shares outstanding because they were anti-dilutive for the three-month periods ended September 30, 2010 and 2009, respectively. There were 144 and 83 restricted stock units excluded from the calculation of diluted common shares outstanding for the three months ended September 30, 2010 and 2009, respectively, because certain performance conditions were not satisfied. Additionally 633 stock options were excluded from the three months ended September 30, 2009 diluted common shares outstanding calculation because certain performance conditions were not met. Options to purchase 1,873 shares of the Company’s common stock and 147 restricted stock units were excluded from the calculation of diluted common shares outstanding for the nine months ended September 30, 2010 because they were anti-dilutive. All of the potentially dilutive securities were excluded from the nine months ended September 30, 2009 because they were anti-dilutive.

Note 12: Fair Value of Assets and Liabilities

Fair Value of Financial Instruments

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

Current assets and current liabilities: The carrying amount reported in the accompanying Consolidated Balance Sheets for current assets and current liabilities, including revolving credit debt due to the short-term maturities and variable interest rates, approximates 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 determined by a valuation model which is based on a conventional discounted cash flow methodology and utilizes assumptions of current market rates. As a majority of the Company’s debts do not trade in active markets, the fair values are highly dependent upon market conditions surrounding the measurement date. The Company calculated a base yield curve using a risk-free rate (a US 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 US Utility BBB+ debt securities. The Company used these yield curve assumptions to derive a base yield and then adjusted the base yield for specific features of the debt securities for differences in credit profile, collateral, tax treatment and call features.

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

 

As of September 30, 2010

   Carrying
Amount
     Fair Value  

Preferred stocks with mandatory redemption requirements

   $ 24,020       $ 28,503   

Long-term debt (excluding capital lease obligations)

     5,410,084         6,263,710   

As of December 31, 2009

   Carrying
Amount
     Fair Value  

Preferred stocks with mandatory redemption requirements

   $ 24,164       $ 26,257   

Long-term debt (excluding capital lease obligations)

     5,336,351         5,633,384   

 

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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 September 30, 2010 and December 31, 2009, respectively:

 

     At Fair Value as of September 30, 2010  

Recurring Fair Value Measures

   Level 1      Level 2     Level 3      Total  

Assets:

          

Restricted funds

   $ 126,304         —          —         $ 126,304   

Rabbi trust investments

     —         $ 1,808        —           1,808   

Deposits

     1,513         —          —           1,513   

Mark-to-market derivative asset

     —           3,228        —           3,228   
                                  

Total assets

     127,817         5,036        —           132,853   
                                  

Liabilities:

          

Deferred compensation obligation

     —           8,560        —           8,560   
                                  

Total liabilities

     —           8,560        —           8,560   
                                  

Total net assets (liabilities)

   $ 127,817       $ (3,524     —         $ 124,293   
                                  
     At Fair Value as of December 31, 2009  

Recurring Fair Value Measures

   Level 1      Level 2     Level 3      Total  

Assets:

          

Restricted funds

   $ 61,232         —          —         $ 61,232   

Rabbi trust investments

     —         $ 2,551        —           2,551   

Deposits

     11,612         —          —           11,612   
                                  

Total assets

     72,844         2,551        —           75,395   
                                  

Liabilities:

          

Deferred compensation obligation

     —           8,881        —           8,881   
                                  

Total liabilities

     —           8,881        —           8,881   
                                  

Total net assets (liabilities)

   $ 72,844       $ (6,330     —         $ 66,514   
                                  

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

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

Deposits – Deposits includes escrow funds and certain other deposits held in trust. The Company includes cash deposits in other current assets. The December 31, 2009 balance included $10,170 for an escrow account related to an agreement the Company’s New Jersey regulated subsidiary had entered into with the City of Trenton, New Jersey to purchase certain assets of Trenton’s water system located in four surrounding townships. The purchase agreement was contested in litigation with a group of Trenton residents, and ultimately put to a voter referendum. The result of the referendum was unfavorable to the Company, and as a result, the agreement to purchase the assets has been terminated. The escrow deposit, plus accrued interest, was returned to the Company on June 30, 2010.

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

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.

Non-recurring Fair Value Measurements

As discussed in Note 3, the Company recognized a goodwill impairment charge of $450,000 for the nine months ended September 30, 2009. The Company’s goodwill valuation model includes significant unobservable inputs and falls within level 3 of the fair value hierarchy.

Note 13: Segment Information

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

 

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The following table includes the Company’s summarized segment information:

 

     As of or for the Three Months Ended
September 30, 2010
 
     Regulated      Non-Regulated      Other     Consolidated  

Net operating revenues

   $ 713,080       $ 80,310       $ (6,444   $ 786,946   

Depreciation and amortization

     72,373         1,854         5,204        79,431   

Total operating expenses, net

     448,694         71,499         (7,202     512,991   

Adjusted EBIT (1)

     264,935         9,157        

Total assets

     12,186,238         244,394         1,553,043        13,983,675   

Capital expenditures

     193,540         1,271         0        194,811   
     As of or for the Three Months Ended
September 30, 2009
 
     Regulated      Non-Regulated      Other     Consolidated  

Net operating revenues

   $ 620,999       $ 65,233       $ (6,276   $ 679,956   

Depreciation and amortization

     69,382         1,522         3,950        74,854   

Total operating expenses, net

     417,568         59,086         (11,104     465,550   

Adjusted EBIT (1)

     203,898         6,563        

Total assets

     11,490,753         242,709         1,612,247        13,345,709   

Capital expenditures

     191,921         799         0        192,720   
     As of or for the Nine Months Ended
September 30, 2010
 
     Regulated      Non-Regulated      Other     Consolidated  

Net operating revenues

   $ 1,834,883       $ 230,153       $ (18,814   $ 2,046,222   

Depreciation and amortization

     211,709         5,562         14,885        232,156   

Total operating expenses, net

     1,263,191         214,285         (27,257     1,450,219   

Adjusted EBIT (1)

     573,381         18,504        

Total assets

     12,186,238         244,394         1,553,043        13,983,675   

Capital expenditures

     516,598         5,492         0        522,090   
     As of or for the Nine Months Ended
September 30, 2009
 
     Regulated      Non-Regulated      Other     Consolidated  

Net operating revenues

   $ 1,673,346       $ 187,029       $ (17,509   $ 1,842,866   

Depreciation and amortization

     203,231         4,296         9,412        216,939   

Impairment charge

     0         0         450,000        450,000   

Total operating expenses, net

     1,215,511         171,587         419,540        1,806,638   

Adjusted EBIT (1)

     459,355         16,665        

Total assets

     11,490,753         242,709         1,612,247        13,345,709   

Capital expenditures

     589,371         3,523         0        592,894   

 

(1) Management evaluates the performance of its segments and allocates resources based on several factors, of which the primary measure is Adjusted EBIT. Adjusted EBIT does not represent cash flow for periods presented and should not be considered as an alternative to net income as an indicator of the Company’s operating performance or as an alternative to cash flows as a source of liquidity. Adjusted EBIT as defined by the Company may not be comparable with Adjusted EBIT as defined by other companies.

The following table reconciles Adjusted EBIT, as defined by the Company, to income (loss) before income taxes:

 

     For the Three Months Ended
September 30, 2010
 
     Regulated     Non-Regulated      Total
Segments
 

Adjusted EBIT

   $ 264,935      $ 9,157       $ 274,092   

Add:

       

Allowance for other funds used during construction

     2,586        —           2,586   

Allowance for borrowed funds used during construction

     1,814        —           1,814   

Less:

       

Interest, net

     (61,548     274         (61,274

Amortization of debt expense

     (1,145     0         (1,145
                         

Segments’ income before income taxes

   $ 206,642      $ 9,431         216,073   

Interest, net

          (13,584

Other

          234   
             

Income before income taxes

        $ 202,723   
             

 

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     For the Three Months Ended
September 30, 2009
 
     Regulated     Non-Regulated      Total
Segments
 

Adjusted EBIT

   $ 203,898      $ 6,563       $ 210,461   

Add:

       

Allowance for other funds used during construction

     2,290        —           2,290   

Allowance for borrowed funds used during construction

     1,674        —           1,674   

Less:

       

Interest, net

     (57,710     690         (57,020

Amortization of debt expense

     (1,995     0         (1,995
                         

Segments’ income before income taxes

   $ 148,157      $ 7,253         155,410   

Interest, net

          (17,104

Other

          3,495   
             

Income before income taxes

        $ 141,801   
             
     For the Nine Months Ended
September 30, 2010
 
     Regulated     Non-Regulated      Total
Segments
 

Adjusted EBIT

   $ 573,381      $ 18,504       $ 591,885   

Add:

       

Allowance for other funds used during construction

     7,144        —           7,144   

Allowance for borrowed funds used during construction

     4,465        —           4,465   

Less:

       

Interest, net

     (185,437     1,175         (184,262

Amortization of debt expense

     (2,816     0         (2,816
                         

Segments’ income before income taxes

   $ 396,737      $ 19,679         416,416   

Interest, net

          (48,045

Other

          6,209   
             

Income before income taxes

        $ 374,580   
             
     For the Nine Months Ended
September 30, 2009
 
     Regulated     Non-Regulated      Total
Segments
 

Adjusted EBIT

   $ 459,355      $ 16,665       $ 476,020   

Add:

       

Allowance for other funds used during construction

     9,208        —           9,208   

Allowance for borrowed funds used during construction

     5,537        —           5,537   

Less:

       

Interest, net

     (171,527     2,389         (169,138

Amortization of debt expense

     (4,739     0         (4,739
                         

Segments’ income before income taxes

   $ 297,834      $ 19,054         316,888   

 

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     For the Nine Months Ended
September 30, 2009
 
     Regulated      Non-Regulated      Total
Segments
 

Impairment charge

           (450,000

Interest, net

           (50,653

Other

           9,184   
              

Loss before income taxes

         $ (174,581
              

 

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

FORWARD-LOOKING STATEMENTS

Certain matters within this Quarterly Report on Form 10-Q include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements included in this Form 10-Q, other than statements of historical fact, may constitute forward-looking statements. Forward-looking statements can be identified by the use of words such as “may,” “should,” “will,” “could,” “estimates,” “predicts,” “potential,” “continue,” “anticipates,” “believes,” “plans,” “expects,” “future” and “intends” and similar expressions. Forward-looking statements may involve known and unknown risks, uncertainties and other factors that may cause the actual results or performance to differ from those projected in the forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. Factors that could cause or contribute to differences in results and outcomes from those in our forward-looking statements include, without limitation, those items discussed in the “Risk Factors” section or other sections in the Company’s Form 10-K for the year ended December 31, 2009 filed with the Securities and Exchange Commission (“SEC”), and subsequent periodic reports, including this report. All forward-looking statements are expressly qualified in their entirety by such risk factors. We undertake no obligation, other than as required by law, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

GENERAL

American Water Works Company, Inc. (herein referred to as “American Water” or the “Company”) is the largest investor-owned United States water and wastewater utility company, as measured both by operating revenue and population served. Our primary business involves the ownership of water and wastewater utilities that provide water and wastewater services to residential, commercial and industrial customers. Our Regulated Businesses that provide these services are generally subject to economic regulation by state regulatory agencies in the states in which they operate. We report the results of these businesses in our Regulated Businesses segment. We also provide services that are not subject to economic regulation by state regulatory agencies. We report the results of these businesses in our Non-Regulated Businesses segment. For further description of our businesses see the “Business” section found in our Form 10-K for the year ended December 31, 2009 filed with the SEC.

You should read the following discussion in conjunction with our Consolidated Financial Statements and related Notes included elsewhere in this Quarterly Report on Form 10-Q and in our Form 10-K for the year ended December 31, 2009 as updated or amended in subsequent filed reports with the SEC.

OVERVIEW

Financial Results American Water’s net income was $124.1 million for the three months ended September 30, 2010 as compared to net income of $91.6 million for the three months ended September 30, 2009. Diluted earnings per average common share were $0.71 for the three months ended September 30, 2010 compared to $0.52 for the three months ended September 30, 2009.

American Water’s net income was $227.7 million for the nine months ended September 30, 2010 compared to a net loss of $269.5 million for the nine months ended September 30, 2009. The Company recognized goodwill impairment charges, net of tax, of $443.0 million for the nine months ended September 30, 2009. Diluted earnings per average common share was $1.30 for the nine months ended September 30, 2010 compared to a diluted loss of ($1.62) for the nine months ended September 30, 2009.

Revenues for the three months ended September 30, 2010 increased by $107.0 million compared to the same period in the prior year. This was primarily due to increased revenues in our Regulated Businesses of $92.1 million, which was mainly attributable to rate increases and increased consumption, and an increase in our Non-Regulated Businesses’ revenues of $15.1 million, which was primarily attributable to higher revenues in the Contract Operations Group of $13.2 million. The increase in Contract Operations Group revenues was primarily due to revenues of $9.3 million attributable to our entry into the industrial Operations and Maintenance (“O&M”) market through an acquisition in December of 2009, hereafter referred to as the “ Contract Operations’ Acquisition,” and increased military contract revenues of $8.1 million due to incremental contract work at two military bases as well as new contracts at two additional bases.

Operating expenses for the three months ended September 30, 2010 were $513.0 million compared to $465.6 million for the three months ended September 30, 2009. This $47.4 million increase was primarily driven by increased operating expenses in our Regulated Businesses’ operation and maintenance costs of $23.8 million due to an increase in production and employee costs, increased operating and maintenance expenses in our Non-Regulated Businesses of $10.9 million corresponding to an increase in revenue, higher depreciation expense of $4.6 million and increased general taxes of $4.7 million for the three months ended September 30, 2010 compared to the same period in the prior year.

 

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Income tax expense increased by $28.4 million, which was mainly the result of higher taxable income for the three months ended September 30, 2010.

Revenues for the nine months ended September 30, 2010 increased by $203.4 million compared to the same period in the prior year. This was primarily due to increased revenues in our Regulated Businesses of $161.5 million, which was largely attributable to rate increases and increased consumption, and an increase in our Non-Regulated Businesses revenues of $43.1 million, which was primarily attributable to higher revenues in the Contract Operations Group of $38.6 million. The increase in Contract Operations Group revenues was primarily due to revenues of $30.1 million attributable to the Contract Operations’ Acquisition as well as increased military contract revenues of $15.8 million partially offset by lower O&M and design and build contract revenues. The increase in the military contract revenues was mainly attributable to incremental contract work at two military bases as well as new contracts at two additional bases.

Operating expenses for the nine months ended September 30, 2010 were $1,450.2 million compared to $1,806.6 million for the nine months ended September 30, 2009. Excluding the impairment charge of $450.0 million, all other operating expenses totaled $1,356.6 million for the nine months ended September 30, 2009. The $93.6 million increase from 2009 to 2010 was primarily driven by an increase in our Non-Regulated Businesses of $42.7 million and increased operating expenses in our Regulated Businesses of $47.7 million for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase in the Non-Regulated Businesses’ operating expenses was primarily the result of higher operating and maintenance expenses of $39.4 million, corresponding with the increased revenue. The Regulated Businesses’ increase in operating expenses was mainly driven by higher operations and maintenance expenses of $30.7 million primarily as a result of increased production and employee related costs, higher depreciation expense of $8.5 million and increased general taxes of $7.8 million.

Other items affecting income (loss) before income taxes for the nine months ended September 30, 2010 as compared to the same period in the prior year include increased interest expense of $12.5 million attributable to the 2009 issuances of long-term debt and decreased allowance for funds used during construction (“AFUDC”) of $3.1 million attributable to construction projects being placed in service in certain of our subsidiaries. Other income was higher compared to 2009 by $3.1 million which was attributable to the release of the remaining balance of a loss reserve of $1.3 million as well as changes in the market value of Company-held deferred compensation. In addition, income tax expense increased by $52.0 million, which was mainly the result of higher taxable income for the nine months ended September 30, 2010. Additionally, the income tax expense included tax benefits of $7.0 million associated with the impairment charge recorded in the nine months ended September 30, 2009

Rate Case Development During the three months ended September 30, 2010, we received authorization for additional annualized revenues from a general rate case in a Virginia subsidiary of $0.6 million and additional annualized revenue of $0.2 million from a general rate increase in Michigan. In addition, new rates which would provide for an additional $25.8 million and $6.9 million of annualized revenues were put into effect under bond subject to refund for our Kentucky and Virginia subsidiaries, respectively. There is no assurance that the bonded amount, or any portion thereof, will be approved. In addition to the above general rate case increases, additional annualized revenues of $3.1 million and $0.2 million resulting from infrastructure charges in our Pennsylvania and New York subsidiaries, respectively, became effective. On February 25, 2010, our New Jersey subsidiary filed a petition with the Board of Public Utilities (“Board”) for approval to recover rates through a surcharge of approximately $3.3 million on an annual basis for an increase in purchased water and sewer treatment cost. On August 4, 2010, the Board authorized the Company to recover in rates a surcharge of approximately $3.1 million on an annual basis for purchased water and sewer treatment costs.

During the three months ended September 30, 2010, we filed one general rate case for our operating subsidiary in Tennessee requesting additional annualized revenues of $10.0 million.

In October 2010, additional annualized revenue of $3.6 million and $5.4 million resulting from infrastructure charges in our Pennsylvania and Indiana subsidiaries, respectively, became effective.

As of October 29, 2010, including the three states for which interim rates are in effect, we were awaiting final orders in nine states requesting additional annualized revenues of $216.7 million. There is no assurance that the filed amount, or any portion thereof, of any requested increases will be granted.

Financing Activities During the nine months ended September 30, 2010, we met our capital resource requirements with internally generated cash as well as funds from external sources primarily through commercial paper borrowings under our credit facilities.

On July 9, 2010, our New Jersey regulated subsidiary closed on a refunding of four outstanding bond issues totaling $150.0 million. In order to accomplish the refunding, the New Jersey Economic Development Authority issued three new series of bonds on behalf of our New Jersey regulated subsidiary. The new bonds have coupon rates of 5.60%, 5.10% and 4.45% and mature in 2034, 2023 and 2023, respectively. Also, in July 2010, we entered into an interest rate swap agreement with a notional amount of $100.0 million, the purpose of which was to mitigate interest cost at the parent company relating to debt that was incurred by our prior owners and was not used in any manner to finance the cash needs of our subsidiaries. On July 27, 2010, we remarketed the $10.6 million of variable rate debt that was held in the Company’s treasury as fixed rate bonds with a coupon rate of 5.25% and a maturity date of 2028.

 

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Also during the three months ended September 30, 2010, American Water Capital Corp. (“AWCC”) closed on two offerings totaling $60 million. The first offering of $35 million in tax-exempt bonds issued through the State of California Pollution Control Financing Authority was closed on August 18, 2010 and has a coupon rate of 5.25% with a 30-year maturity and a 10-year call option. The proceeds from this bond offering are required to be used to fund specific California-American Water Company projects. The second offering of $25 million in tax-exempt water facility revenue bonds issued through the Indiana Finance Authority was closed on September 16, 2010 and has a coupon rate 4.85% with a 30-year maturity and a 10-year call option. The proceeds from this bond offering are required to be used to fund water facility projects in Indiana-American Water Company’s service territory.

On November 1, 2010, our New Jersey regulated subsidiary closed on a refinancing of two bond issues of $35.0 million and $40.0 million, with original coupon rates of 5.95% and 5.60% and maturity dates of 2029 and 2025, respectively. The two new bond issues of $35.0 million and $40.0 million have interest rates of 4.88% and 4.70% and maturity dates of 2029 and 2025, respectively.

Other Matters

Dividend On March 1, 2010 and June 2, 2010, the Company made cash dividend payments of $0.21 per share to all common shareholders of record as of February 18, 2010 and May 18, 2010, respectively. On September 1, 2010, the Company made a cash dividend payment of $0.22 per share to all common shareholders of record as of August 18, 2010, amounting to $38.5 million.

In March and June of 2009, the Company made cash dividend payments of $0.20 per share to all common shareholders of record as of February 18, 2009 and May 18, 2009, respectively. In September 2009, the Company made a cash dividend payment of $0.21 per share to all common shareholders of record as of August 18, 2009, amounting to $36.7 million.

On October 29, 2010, the Company declared a quarterly cash dividend payment of $0.22 per share payable on December 1, 2010 to all shareholders of record as of November 18, 2010.

On October 19, 2010, the California Public Utilities Commission issued new rules governing affiliate transactions and the use of regulated utility assets for non tariffed utility services. Potential impacts of the new rules on the Company and California–American Water Company’s operations and relationships with its affiliates are currently under review.

Results of Operations

Three Months Ended September 30, 2010 Compared To Three Months Ended September 30, 2009

 

     For the three months ended
September 30,
    Favorable
(Unfavorable)
Change
 
(In thousands, except per share data)    2010     2009    

Operating revenues

   $ 786,946      $ 679,956      $ 106,990   
                        

Operating expenses

      

Operation and maintenance

     378,034        340,862        (37,172

Depreciation and amortization

     79,431        74,854        (4,577

General taxes

     55,316        50,618        (4,698

(Gain) loss on sale of assets

     210        (784     (994
                        

Total operating expenses, net

     512,991        465,550        (47,441
                        

Operating income

     273,955        214,406        59,549   
                        

Other income (expenses)

      

Interest, net

     (74,858     (74,124     (734

Allowance for other funds used during construction

     2,586        2,290        296   

Allowance for borrowed funds used during construction

     1,814        1,674        140   

Amortization of debt expense

     (1,285     (2,135     850   

Other, net

     511        (310     821   
                        

Total other income (expenses)

     (71,232     (72,605     1,373   
                        

Income before income taxes

     202,723        141,801        60,922   

Provision for income taxes

     78,609        50,165        (28,444
                        

Net income

   $ 124,114      $ 91,636      $ 32,478   
                        

Income per common share:

      

Basic

   $ 0.71      $ 0.52     

Diluted

   $ 0.71      $ 0.52     

Average common shares outstanding during the period:

      

Basic

     174,859        174,595     

Diluted

     175,062        174,691     

 

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The following table summarizes certain financial information for our Regulated and Non-Regulated Businesses for the periods indicated (without giving effect to inter-segment eliminations):

 

     For the three months ended September 30,  
     2010      2009  
     Regulated
Businesses
     Non-Regulated
Businesses
     Regulated
Businesses
     Non-Regulated
Businesses
 
     (In thousands)  

Operating revenues

   $ 713,080       $ 80,310       $ 620,999       $ 65,233   

Adjusted EBIT(1)

   $ 264,935       $ 9,157       $ 203,898       $ 6,563   

 

(1) Adjusted EBIT, a non-GAAP measure, is defined as earnings before interest and income taxes from continuing operations. Management evaluates the performance of its segments and allocates resources based on several factors, of which the primary measure is Adjusted EBIT. Adjusted EBIT does not represent cash flow for the periods presented and should not be considered as an alternative to net income as an indicator of the Company’s operating performance or as an alternative to cash flows as a source of liquidity. Adjusted EBIT as defined by the Company may not be comparable with Adjusted EBIT as defined by other companies. For the reconciliation of Adjusted EBIT, as defined by the Company, to income before income taxes, see Financial Statement Note 13.

Operating revenues Our primary business involves the ownership of water and wastewater utilities that provide water and wastewater services to residential, commercial and industrial customers as well as sales to public authorities. The table below details the additional annualized revenues resulting from rate authorizations, including infrastructure charges, which were granted in the third quarter of 2010.

 

     Annualized Rate
Increases Granted
 
     (In millions)  

State

  

General rate case:

  

Kentucky*

   $ 25.8   

Virginia*

     7.5   

Michigan

     0.2   
        

Subtotal- General Rate Cases

     33.5   
        

Infrastructure Charges:

  

Pennsylvania

     3.1   
        

Subtotal- Infrastructure Charges

     3.1   
        

Total

   $ 36.6   
        

 

* Rate case not yet finalized; however, new rates were put into effect under bond subject to refund for the total Kentucky amount of $25.8 million and $6.9 million of the Virginia amount. There is no assurance that the bonded amount, or any portion thereof, will be approved.

Operating revenues increased by $107.0 million, or 15.7%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. Regulated Businesses’ revenues increased by $92.1 million, or 14.8%, for the three months ended September 30, 2010 compared to the same period in the prior year. The Non-Regulated Businesses’ revenues for the three months ended September 30, 2010 increased by $15.1 million, or 23.1%, compared to the three months ended September 30, 2009.

The increase in the Regulated Businesses for the three months ended September 30, 2010 compared to the three months ended September 30, 2009 was primarily due to rate increases obtained through rate authorizations for a number of our operating companies of which the third quarter 2010 impact was approximately $52.8 million. Revenues for the three months ended September 30, 2010 increased by approximately $37.6 million due to higher demand as compared to the same period in the prior year. Most of this consumption increase occurred in our regulated subsidiaries in the Mid-Atlantic region of the United States as a result of the warmer/drier weather. Offsetting these increases was a decrease in surcharge and balancing account revenues of $1.6 million.

 

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The increase in revenues from the Non-Regulated Businesses was primarily attributable to higher revenues in our Contract Operations Group totaling $13.2 million as a result of the Contract Operations’ Acquisition which contributed $9.3 million to the increase as well as incremental revenues associated with military construction and O&M projects of $8.1 million partially offset by lower revenues associated with our O&M and design and build contracts.

The following table sets forth the percentage of Regulated Businesses’ revenues and water sales volume by customer class:

 

     For the three months ended September 30,  
     2010     2009 *     2010     2009 *  
     Operating Revenues     Water Sales Volume  
     (Dollars in thousands, gallons in millions)  

Customer Class

                    

Water service:

                    

Residential

   $ 414,505         58.1   $ 353,397         56.9     65,010         53.4     60,714         53.6

Commercial

     143,305         20.1     126,515         20.4     27,983         23.0     26,265         23.2

Industrial

     31,431         4.4     27,955         4.5     11,876         9.8     10,149         9.0

Public and other

     84,249         11.8     74,779         12.0     16,742         13.8     16,114         14.2

Other water revenues

     4,972         0.7     6,820         1.1     —           —          —           —     
                                                                    

Total water revenues

     678,462         95.1     589,466         94.9     121,611         100.0     113,242         100.0
                                            

Wastewater service

     23,900         3.4     22,655         3.7          

Other revenues

     10,718         1.5     8,878         1.4          
                                            
   $ 713,080         100.0   $ 620,999         100.0          
                                            

 

  * Certain reclassifications have been made between customer classes to conform with 2010 presentation.

The following discussion related to water services indicates the increase or decrease in the Regulated Businesses’ revenues and associated water sales volumes in gallons by customer class.

Water Services – Water service operating revenues from residential customers for the three months ended September 30, 2010 totaled $414.5 million, a $61.1 million increase, or 17.3%, over the same period of 2009, mainly due to rate increases and an increase in sales volume. The volume of water sold to residential customers increased by 7.1% for the three months ended September 30, 2010 to 65.0 billion gallons, from 60.7 billion gallons for the same period in 2009. We believe this increase is attributable to warmer and drier weather during the quarter primarily in the Mid-Atlantic region of the United States compared to the three months ended September 30, 2009.

Water service operating revenues from commercial water customers for the three months ended September 30, 2010 increased by $16.8 million, or 13.3%, to $143.3 million mainly due to rate increases in addition to an increase in sales volume compared to the same period in 2009. The volume of water sold to commercial customers increased by 6.5% for the three months ended September 30, 2010 to 28.0 billion gallons, from 26.3 billion gallons for the three months ended September 30, 2009.

Water service operating revenues from industrial customers totaled $31.4 million for the three months ended September 30, 2010, an increase of $3.5 million, or 12.4%, from those recorded for the same period of 2009 mainly due to rate increases in addition to an increase in sales volume. The volume of water sold to industrial customers totaled 11.9 billion gallons for the three months ended September 30, 2010, an increase of 17.0% from the 10.1 billion gallons for the three months ended September 30, 2009. We believe this increase to be associated with slight improvements in the economic environment in communities that we serve.

Water service operating revenues from public and other customers, including municipal governments, other governmental entities and resale customers increased $9.5 million, or 12.7%, for the three months ended September 30, 2010 to $84.2 million compared to the same period in the prior year mainly due to rate increases. Revenues from municipal governments for fire protection services and customers requiring special private fire service facilities totaled $31.2 million for the three months ended September 30, 2010, an increase of $2.2 million over the same period of 2009. Revenues generated by sales to governmental entities and resale customers for the three months ended September 30, 2010 totaled $53.0 million, an increase of $7.2 million from the three months ended September 30, 2009.

 

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Wastewater services – Our subsidiaries provide wastewater services in 12 states. Revenues from these services increased by $1.2 million, or 5.5%, to $23.9 million for the three months ended September 30, 2010. The increase was attributable to increases in rates charged to customers in a number of our operating companies.

Other revenues – Other revenues include such items as reconnection charges, initial application service fees, rental revenues, revenue collection services for others and similar items. For the three months ended September 30, 2010, other revenues increased by $1.8 million mainly due to an increase in work for a managed contract as well as rental revenue compared to the same period in the prior year.

Operation and maintenance Operation and maintenance expense increased $37.2 million, or 10.9%, for the three months ended September 30, 2010 compared to the same period in the prior year.

Operation and maintenance expenses for the three months ended September 30, 2010 and 2009, by major expense category, were as follows:

 

     For the three months ended September 30,  
     2010      2009      Increase
(Decrease)
     Percentage  
     (In thousands)  

Production costs

   $ 95,746       $ 86,673       $ 9,073         10.5

Employee-related costs

     157,085         139,633         17,452         12.5

Operating supplies and services

     62,937         60,227         2,710         4.5

Maintenance materials and services

     37,270         31,723         5,547         17.5

Customer billing and accounting

     12,909         12,690         219         1.7

Other

     12,087         9,916         2,171         21.9
                             

Total

   $ 378,034       $ 340,862       $ 37,172         10.9
                             

As is noted in the various expense category commentaries below, a driver of the increase in operations and maintenance expense is higher expenses in our Non-Regulated Businesses associated with the combined effects of our Contract Operations’ Acquisition and its related reorganization and transitional costs totaling $8.5 million.

Production costs, including fuel and power, purchased water, chemicals and waste disposal increased by $9.1 million, or 10.5%, for the three months ended September 30, 2010 compared to the same period in the prior year. Production costs, by major expense type were as follows:

 

     For the three months ended September 30,  
     2010      2009      Increase
(Decrease)
     Percentage  
     (In thousands)  

Fuel and power

   $ 33,166       $ 30,804       $ 2,362         7.7

Purchased water

     34,618         29,367         5,251         17.9

Chemicals

     19,061         18,130         931         5.1

Waste disposal

     8,901         8,372         529         6.3
                             

Total

   $ 95,746       $ 86,673       $ 9,073         10.5
                             

Fuel and power costs increased in our Regulated Businesses by $2.1 million primarily due to higher electricity and fuel prices as well as increased production volumes. The increase in purchased water is primarily associated with our Regulated Businesses and is attributable to rate increases resulting from higher costs incurred by our suppliers. The majority of this purchased water increase is in states which permit us to pass-through this increase to our customers outside of a full rate proceeding. The increase in chemical costs is primarily attributable to increased consumption slightly offset by lower chemical costs in our Regulated Businesses as a result of favorable contract pricing.

Employee-related costs including wage and salary, group insurance, and pension expense increased $17.5 million or 12.5% for the three months ended September 30, 2010, compared to the same period in the prior year. These employee-related costs represented 41.6% and 41.0% of operation and maintenance expenses for the three months ended September 30, 2010 and 2009, respectively.

 

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     For the three months ended September 30,  
     2010      2009      Increase
(Decrease)
    Percentage  
     (In thousands)  

Salaries and wages

   $ 114,991       $ 99,778       $ 15,213        15.2

Pensions

     15,849         13,573         2,276        16.8

Group insurance

     20,647         20,575         72        0.3

Other benefits

     5,598         5,707         (109     (1.9 )% 
                            

Total

   $ 157,085       $ 139,633       $ 17,452        12.5
                            

The increase in salaries and wages can be attributed to additional employees as a result of the Contract Operations’ Acquisition, totaling approximately $3.9 million, as well as wage increases, higher incentive compensation, increased severance expenses and increased overtime costs in certain of our regulated operating companies. Pension expense increased for the three months ended September 30, 2010 due to increased pension contributions by certain of our regulated operating companies whose costs are recovered based on Employee Retirement Income Security Act of 1974 (“ERISA”) minimum funding requirements. This increase was partially offset by a decrease in the amortization of actuarial losses attributable to higher than expected returns on plan assets in 2009.

Operating supplies and services include the day-to-day expenses of office operation, legal and other professional services, as well as information systems and other office equipment rental charges. For the three months ended September 30, 2010, these costs increased by $2.7 million, or 4.5%, compared to the same period in 2009.

 

     For the three months ended September 30,  
     2010      2009*      Increase
(Decrease)
    Percentage  
     (In thousands)  

Contracted services

   $ 23,869       $ 20,578       $ 3,291        16.0

Office supplies and services

     16,652         15,855         797        5.0

Transportation

     8,611         8,763         (152     (1.7 )% 

Rents

     6,149         5,793         356        6.1

Other

     7,656         9,238         (1,582     (17.1 )% 
                            

Total

   $ 62,937       $ 60,227       $ 2,710        4.5
                            

* Certain reclassifications have been made between categories in order for 2009 to conform with 2010 presentation.

Contracted services increased for the three months ended September 30, 2010 compared to the same period in 2009 primarily due to increased construction related activity in the Contract Operations Group related to military contracts which corresponds with the increased revenues. Office supplies and services increased primarily due to the Contract Operations’ Acquisition. The decrease in the “Other” category is mainly attributable to the establishment of a regulatory asset for a $3.5 million payment previously made by our California operating company to the California Department of Fish and Game (“CDFG”) on behalf of the National Oceanographic and Atmospheric Administration (“NOAA”) as a result of an advice letter issued by the California Public Utility Commission which now allows for rate recovery of such payment. This reduction was offset by reserves of $1.4 million for costs deemed not recoverable at this time in one of our operating companies as well as increased costs associated with the Contract Operations’ Acquisition.

Maintenance materials and services, which include emergency repairs as well as costs for preventive maintenance, increased $5.5 million or by 17.5%, for the three months ended September 30, 2010 compared to the same period in the prior year.

 

     For the three months ended September 30,  
     2010      2009      Increase
(Decrease)
     Percentage  
     (In thousands)  

Maintenance services and supplies

   $ 26,543       $ 21,450       $ 5,093         23.7

Removal costs, net

     10,727         10,273         454         4.4
                             

Total

   $ 37,270       $ 31,723       $ 5,547         17.5
                             

The Regulated Businesses’ maintenance materials and service costs increased by $3.7 million for the three months ended September 30, 2010. In addition to higher removal costs, maintenance services and supplies increased due to higher levels of meter testing, pump, tank and well maintenance, and paving costs throughout our regulated subsidiaries. The Non-Regulated Businesses’ expense increased $1.8 million primarily due to increased costs in our Homeowner Services Group, associated with an increase in its customer base.

 

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Customer billing and accounting expenses increased by $0.2 million, or 1.7% for the three months ended September 30, 2010 compared to the same period in the prior year.

 

     For the three months ended September 30,  
     2010      2009      Increase
(Decrease)
    Percentage  
     (In thousands)  

Uncollectible accounts expense

   $ 5,884       $ 5,924       $ (40     (0.7 )% 

Postage

     3,327         3,261         66        2.0

Other

     3,698         3,505         193        5.5
                            

Total

   $ 12,909       $ 12,690       $ 219        1.7
                            

Other operation and maintenance expenses include casualty and liability insurance premiums and regulatory costs. These costs decreased by $2.2 million, or 21.9%, in 2010.

 

     For the three months ended September 30,  
     2010      2009      Increase
(Decrease)
    Percentage  
     (In thousands)  

Insurance

   $ 9,084       $ 6,904       $ 2,180        31.6

Regulatory expenses

     3,003         3,012         (9     (0.3 )% 
                            

Total

   $ 12,087       $ 9,916       $ 2,171        21.9
                            

The increase in insurance expense is primarily due to favorable claims experience in 2009.

Depreciation and amortization Depreciation and amortization expense increased by $4.6 million, or 6.1%, for the three months ended September 30, 2010 compared to the same period in the prior year as a result of additional utility plant being placed in service.

General taxes General taxes expense, which includes taxes for property, payroll, gross receipts, and other miscellaneous items, increased by $4.7 million, or 9.3%, in the three months ended September 30, 2010 compared to the three months ended September 30, 2009. This increase was mainly due to higher gross receipts taxes of $1.9 million, primarily in our New Jersey regulated subsidiary. Also contributing to the increase were higher payroll taxes resulting from the increase in salaries and wages as well as increased capital stock and property tax expenses.

Other income (expenses) Interest expense, net of interest income, which is the primary component of our other income (expenses), increased by $0.7 million, or 1.0%, for the three months ended September 30, 2010 compared to the same period in the prior year. The increase is primarily due to the refinancing of short-term debt with long-term debt during 2009 as well as increased borrowing associated with capital expenditures. During 2009 a significant portion of this debt was refinanced to long-term fixed rate debt whose rates are higher than the short-term rates that existed for the three months ended September 30, 2009. This increase was offset by the recognition of $3.6 million of the fair value uplift for a debt issuance that was called for early redemption in July 2010.

Provision for income taxes The effective tax rates for the three months ended September 30, 2010 and 2009 were 38.8% and 35.4% respectively. Our consolidated provision for income taxes increased $28.4 million, or 56.7%, to $78.6 million for the three months ended September 30, 2010. The increase is primarily due to the fact that the 2009 effective tax rate included an impact of tax law changes in one of our subsidiaries as well as other discrete items.

Net income Net income for the three months ended September 30, 2010 was $124.1 million compared to a net income of $91.6 million for the three months ended September 30, 2009. The variation between the periods is the result of the aforementioned changes.

 

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Results of Operations

Nine Months Ended September 30, 2010 Compared To Nine Months Ended September 30, 2009

 

     For the nine months ended
September 30,
    Favorable
(Unfavorable)
Change
 
(In thousands, except per share data)    2010     2009    

Operating revenues

   $ 2,046,222      $ 1,842,866      $ 203,356   
                        

Operating expenses

      

Operation and maintenance

     1,053,320        985,861        (67,459

Depreciation and amortization

     232,156        216,939        (15,217

General taxes

     164,610        154,814        (9,796

Gain (loss) on sale of assets

     133        (976     (1,109

Impairment charge

     0        450,000        450,000   
                        

Total operating expenses, net

     1,450,219        1,806,638        356,419   
                        

Operating income

     596,003        36,228        559,775   
                        

Other income (expenses)

      

Interest, net

     (232,307     (219,791     (12,516

Allowance for other funds used during construction

     7,144        9,208        (2,064

Allowance for borrowed funds used during construction

     4,465        5,537        (1,072

Amortization of debt expense

     (3,233     (5,158     1,925   

Other, net

     2,508        (605     3,113   
                        

Total other income (expenses)

     (221,423     (210,809     (10,614
                        

Income (loss) before income taxes

     374,580        (174,581     549,161   

Provision for income taxes

     146,907        94,873        (52,034
                        

Net income (loss)

   $ 227,673      $ (269,454   $ 497,127   
                        

Income (loss) per common share:

      

Basic

   $ 1.30      $ (1.62  

Diluted

   $ 1.30      $ (1.62  

Average common shares outstanding during the period:

      

Basic

     174,785        165.992     

Diluted

     174,919        165,992     

The following table summarizes certain financial information for our Regulated and Non-Regulated Businesses for the periods indicated (without giving effect to inter-segment eliminations):

 

     For the nine months ended September 30,  
     2010      2009  
     Regulated
Businesses
     Non-Regulated
Businesses
     Regulated
Businesses
     Non-Regulated
Businesses
 
     (In thousands)  

Operating revenues

   $ 1,834,883       $ 230,153       $ 1,673,346       $ 187,029   

Adjusted EBIT(1)

   $ 573,381       $ 18,504       $ 459,355       $ 16,665   

 

(1) Adjusted EBIT, a non-GAAP measure, is defined as earnings before interest and income taxes from continuing operations. Management evaluates the performance of its segments and allocates resources based on several factors, of which the primary measure is Adjusted EBIT. Adjusted EBIT does not represent cash flow for the periods presented and should not be considered as an alternative to net income as an indicator of the Company’s operating performance or as an alternative to cash flows as a source of liquidity. Adjusted EBIT as defined by the Company may not be comparable with Adjusted EBIT as defined by other companies. For the reconciliation of Adjusted EBIT, as defined by the Company, to income (loss) before income taxes, see Financial Statement Note 13.

Operating revenues Our primary business involves the ownership of water and wastewater utilities that provide water and wastewater services to residential, commercial and industrial customers as well as sales to public authorities. The table below details the annualized revenues resulting from rate authorizations, including infrastructure charges, which were granted during the first nine months of 2010.

 

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     Annualized Rate
Increases Granted
 
     (In millions)  

State

  

General rate case:

  

Illinois

   $ 40.7   

Indiana

     31.5   

Missouri

     24.8   

Kentucky*

     25.8   

California

     14.6   

Virginia*

     7.5   

Ohio

     2.6   

New Mexico

     0.5   

Michigan

     0.2   
        

Subtotal- General Rate Cases

     148.2   
        

Infrastructure Charges:

  

Pennsylvania

     4.9   

Missouri

     3.2   

Illinois

     0.7   

New York

     0.4   
        

Subtotal- Infrastructure Charges

     9.2   
        

Total

   $ 157.4   
        

 

* Rate case not yet finalized; however, new rates were put into effect under bond subject to refund for the total Kentucky amount of $25.8 million and $6.9 million of the Virginia amount. There is no assurance that the bonded amount, or any portion thereof, will be approved.

Our results of operations are significantly impacted by rates authorized by the state regulatory commissions in the states in which we operate. Operating revenues increased by $203.4 million, or 11.0%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. Regulated Businesses’ revenues increased by $161.5 million, or 9.7%, for the nine months ended September 30, 2010 compared to the same period in the prior year. The Non-Regulated Businesses’ revenues for the nine months ended September 30, 2010 increased by $43.1 million, or 23.1%, compared to the nine months ended September 30, 2009.

The increase in revenues from the Regulated Businesses for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 was primarily due to rate increases obtained through rate authorizations for a number of our operating companies of which the year-to-date 2010 impact was approximately $107.7 million. In addition, for the nine months ended September 30, 2010, surcharge and balancing account revenues increased by $3.8 million and sewer and fire service revenues increased by $2.0 million compared to the same period in the prior year. Revenues for the nine months ended September 30, 2010 increased by approximately $41.1 million due to higher demand as compared to the same period in the prior year, mainly due to increased volumes in our subsidiaries in the Mid-Atlantic region of the United States.

The net increase in revenues from the Non-Regulated Businesses was primarily attributable to an increase in Contract Operations Group revenues primarily due to higher revenues totaling $30.1 million resulting from the Contract Operations’ Acquisition as well as incremental revenues associated with military construction and O&M projects of $15.8 million as a result of being fully operational at Fort Hood and Fort Polk and the addition of Fort Meade and Fort Belvoir contracts. These increases were partially offset by lower revenues associated with our O&M and design and build contracts. In addition, our Homeowner Services Group revenues increased by $4.2 million mainly as a result of increased product penetration within its existing customer base.

The following table sets forth the percentage of Regulated Businesses’ revenues and water sales volume by customer class:

 

     For the nine months ended September 30,  
     2010     2009 *     2010     2009*  
     Operating Revenues     Water Sales Volume  
     (Dollars in thousands, gallons in millions)  

Customer Class

                    

Water service:

                    

Residential

   $ 1,050,833         57.3   $ 958,263         57.3     156,493         52.6     154,150         53.3

Commercial

     356,619         19.4     326,242         19.5     67,046         22.6     65,149         22.5

Industrial

     85,451         4.7     76,402         4.5     30,822         10.4     27,404         9.5

Public and other

     223,417         12.2     205,651         12.3     42,960         14.4     42,430         14.7

Other water revenues

     19,741         1.1     16,805         1.0     —           —          —           —     
                                                                    

Total water revenues

     1,736,061         94.7     1,583,363         94.6     297,321         100.0     289,133         100.0
                                            

Wastewater service

     70,372         3.8     66,397         4.0          

Other revenues

     28,450         1.5     23,586         1.4          
                                            
   $ 1,834,883         100.0   $ 1,673,346         100.0          
                                            

 

  * Certain reclassifications have been made between customer classes to conform with 2010 presentation.

 

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The following discussion related to water services indicates the increase in the Regulated Businesses’ revenues and associated water sales volumes in gallons by customer class.

Water Services – Water service operating revenues from residential customers for the nine months ended September 30, 2010 totaled $1,050.8 million, a $92.6 million increase, or 9.7%, over the same period of 2009, mainly due to rate increases and an increase in sales volume. The volume of water sold to residential customers increased by 1.5% for the nine months ended September 30, 2010 to 156.5 billion gallons, from 154.2 billion gallons for the same period in 2009. We believe this increase is attributable to warmer and drier weather in the Mid-Atlantic region of the United States primarily in the third quarter of 2010 compared to the same period in the prior year.

Water service operating revenues from commercial water customers for the nine months ended September 30, 2010 increased by $30.4 million, or 9.3%, to $356.6 million, mainly due to rate increases in addition to an increase in sales volume compared to the same period in 2009. The volume of water sold to commercial customers increased by 2.9% for the nine months ended September 30, 2010, to 67.0 billion gallons, from 65.1 billion gallons for the nine months ended September 30, 2009.

Water service operating revenues from industrial customers totaled $85.5 million for the nine months ended September 30, 2010, an increase of $9.0 million, or 11.8%, from those recorded for the same period of 2009 mainly due to rate increases in addition to an increase in sales volume. The volume of water sold to industrial customers totaled 30.8 billion gallons for the nine months ended September 30, 2010, an increase of 12.5% from the 27.4 billion gallons for the nine months ended September 30, 2009.

Water service operating revenues from public and other customers, including municipal governments, other governmental entities and resale customers increased $17.8 million, or 8.6%, for the nine months ended September 30, 2010 to $223.4 million from $205.7 million in the same period in 2009 mainly due to rate increases. Revenues from municipal governments for fire protection services and customers requiring special private fire service facilities totaled $90.0 million for the nine months ended September 30, 2010, an increase of $5.3 million over the same period of 2009. Revenues generated by sales to governmental entities and resale customers for the nine months ended September 30, 2010 totaled $133.4 million, an increase of $12.5 million from the nine months ended September 30, 2009.

Wastewater services – Our subsidiaries provide wastewater services in 12 states. Revenues from these services increased by $4.0 million, or 6.0%, to $70.4 million for the nine months ended September 30, 2010, from $66.4 million for the same period of 2009. The increase was attributable to increases in rates charged to customers in a number of our operating companies.

Other revenues – Other revenues include such items as reconnection charges, initial application service fees, rental revenues, revenue collection services for others and similar items. For the nine months ended September 30, 2010, these revenues increased by $4.9 million mainly due to an increase in work for a managed contract as well as rental revenue compared to the same period in the prior year.

Operation and maintenance Operation and maintenance expense increased $67.5 million, or 6.8%, for the nine months ended September 30, 2010 compared to the same period in the prior year.

Operation and maintenance expenses for the nine months ended September 30, 2010 and 2009, by major expense category, were as follows:

 

     For the nine months ended September 30,  
     2010      2009      Increase
(Decrease)
    Percentage  
     (In thousands)  

Production costs

   $ 250,122       $ 232,861       $ 17,261        7.4

Employee-related costs

     445,675         405,404         40,271        9.9

Operating supplies and services

     178,159         175,687         2,472        1.4

Maintenance materials and services

     112,157         95,728         16,429        17.2

Customer billing and accounting

     37,029         36,689         340        0.9

Other

     30,178         39,492         (9,314     (23.6 )% 
                            

Total

   $ 1,053,320       $ 985,861       $ 67,459        6.8
                            

 

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As is noted in the various expense category commentaries below, a major driver of the increase in operations and maintenance expense is higher expenses in our Non-Regulated Businesses associated with the combined effects of our Contracts Operations’ Acquisition and its related reorganization and transitional costs of $29.3 million.

Production costs, including fuel and power, purchased water, chemicals and waste disposal increased by $17.3 million, or 7.4%, for the nine months ended September 30, 2010 compared to the same period in the prior year. Production costs, by major expense type were as follows:

 

     For the nine months ended September 30,  
     2010      2009      Increase
(Decrease)
    Percentage  
     (In thousands)  

Fuel and power

   $ 88,574       $ 84,196       $ 4,378        5.2

Purchased water

     85,636         74,568         11,068        14.8

Chemicals

     47,597         49,519         (1,922     (3.9 )% 

Waste disposal

     28,315         24,578         3,737        15.2
                            

Total

   $ 250,122       $ 232,861       $ 17,261        7.4
                            

The increase in our fuel and power costs was primarily driven by higher costs in our Non-Regulated Business of $3.0 million, most of which is attributable to our Contract Operations’ Acquisition. Fuel and power costs increased in the Regulated Business by $1.4 million primarily corresponding with the increase in usage. The increase in purchased water, which is primarily associated with our Regulated Businesses, is due to rate increases resulting from higher costs incurred by our suppliers. The majority of this purchased water increase is in states which permit us to pass-through this increase to our customers outside of a full rate proceeding. The decrease in chemical costs is primarily attributable to lower chemical costs in our Regulated Businesses as a result of favorable contract pricing. Waste disposal costs increased primarily due to increased rates in one of our Regulated operating companies as well as higher disposal costs attributable to the Contract Operations’ Acquisition, which accounted for $1.6 million of the increase.

Employee-related costs including wage and salary, group insurance, and pension expense increased $40.3 million, or 9.9%, for the nine months ended September 30, 2010, compared to the same period in the prior year. These employee-related costs represented 42.3% and 41.1% of operation and maintenance expenses for the nine months ended September 30, 2010 and 2009, respectively.

 

     For the nine months ended September 30,  
     2010      2009      Increase
(Decrease)
    Percentage  
     (In thousands)  

Salaries and wages

   $ 326,622       $ 288,550       $ 38,072        13.2

Pensions

     40,609         41,873         (1,264     (3.0 )% 

Group insurance

     60,267         59,285         982        1.7

Other benefits

     18,177         15,696         2,481        15.8
                            

Total

   $ 445,675       $ 405,404       $ 40,271        9.9
                            

The increase in salaries and wages and other benefits was primarily due to the addition of employees as a result of the Contract Operations’ Acquisition totaling approximately $12.3 million and $2.2 million, respectively. The remainder of the increase in salaries and wages was due to wage increases, higher incentive compensation and severance expense as well as increased overtime costs of $3.9 million in certain of our regulated operating companies. Pension expense decreased for the nine months ended September 30, 2010 due to a decrease in the amortization of actuarial losses attributable to higher than expected returns on plan assets in 2009. This increase was partially offset by increased pension contributions by certain of our regulated operating companies whose costs are recovered based on Employee Retirement Income Security Act of 1974 (“ERISA”) minimum funding requirements.

 

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Operating supplies and services include the day-to-day expenses of office operation, legal and other professional services, as well as information systems and other office equipment rental charges. For the nine months ended September 30, 2010, these costs increased by $2.5 million, or 1.4%, compared to the same period in 2009.

 

     For the nine months ended September 30,  
     2010      2009*      Increase
(Decrease)
    Percentage  
     (In thousands)  

Contracted services

   $ 59,744       $ 59,442       $ 302        0.5

Office supplies and services

     50,998         47,565         3,433        7.2

Transportation

     25,005         22,497         2,508        11.1

Rents

     18,681         16,473         2,208        13.4

Other

     23,731         29,710         (5,979     (20.1 )% 
                            

Total

   $ 178,159       $ 175,687       $ 2,472        1.4
                            

 

  * Certain reclassifications have been made between categories in order for 2009 to conform with 2010 presentation.

Contracted services increased slightly for the nine months ended September 30, 2010 compared to the same period in 2009 due to increased construction activity in the Contract Operations Group related to military contracts. Offsetting this increase was lower temporary labor expenses due to the filling of vacant positions and a reduction in our legal and accounting expenses. Office supplies and services increased primarily due to costs related to marketing programs for our Homeowner Services Group in addition to our Contract Operations’ Acquisition. The increase in transportation costs was due to higher gasoline prices during the nine months ended September 30, 2010 compared to the same period in 2009. The decrease in the “Other” category is primarily due to the aforementioned advice letter approval for rate recovery of a $3.5 million payment to the CDFG on behalf of NOAA in the third quarter of 2010.

Maintenance materials and services, which include emergency repairs as well as costs for preventive maintenance, increased $16.4 million, or by 17.2%, for the nine months ended September 30, 2010 compared to the same period in the prior year.

 

     For the nine months ended September 30,  
     2010      2009      Increase
(Decrease)
     Percentage  
     (In thousands)  

Maintenance services and supplies

   $ 79,932       $ 65,311       $ 14,621         22.4

Removal costs, net

     32,225         30,417         1,808         5.9
                             

Total

   $ 112,157       $ 95,728       $ 16,429         17.2
                             

The Regulated Businesses’ maintenance materials and service costs increased by $8.2 million for the nine months ended September 30, 2010. In addition to higher removal costs, tank painting expenses for our New Jersey subsidiary were higher by $1.5 million. The remaining increase for the Regulated Business was due to higher levels of meter testing, pump, tank and well maintenance, and paving costs throughout our regulated subsidiaries. The Non-Regulated Businesses’ expense increased $8.2 million primarily due to an increased cost for Homeowner Services Group of $2.6 million associated with an increase in its customer base, higher maintenance expenses in the Contract Operations Group including increased cost associated with the Contract Operations’ Acquisition of $2.4 million and our military contracts resulting from incremental construction projects and growth mainly related to the Fort Meade and Fort Belvoir locations.

Customer billing and accounting expenses increased by $0.3 million, or 0.9%, for the nine months ended September 30, 2010 compared to the same period in the prior year.

 

     For the nine months ended September 30,  
     2010      2009      Increase
(Decrease)
    Percentage  
     (In thousands)  

Uncollectible accounts expense

   $ 16,356       $ 17,337       $ (981     (5.7 )%&