The following discussion should be read together with the unaudited Consolidated Financial Statements and Notes thereto included elsewhere in this Form 10-Q, and in the Company's Form 10-K for the year endedDecember 31, 2019 . This discussion contains forward-looking statements that are based on management's current expectations, estimates and projections about the Company's business, operations and financial performance. The cautionary statements made in this Form 10-Q should be read as applying to all related forward-looking statements whenever they appear in this Form 10-Q. The Company's actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of a number of factors, including those that are discussed under "Forward-Looking Statements," and elsewhere in this Form 10-Q. The Company has a disclosure committee consisting of members of senior management and other key employees involved in the preparation of the Company'sSEC reports. The committee is actively involved in the review and discussion of the Company'sSEC filings. OverviewAmerican Water is the largest and most geographically diverse, publicly traded water and wastewater utility company inthe United States , as measured by both operating revenues and population served. The Company's primary business involves the ownership of utilities that provide water and wastewater services to residential, commercial, industrial, public authority, fire service and sale for resale customers, collectively presented as the "Regulated Businesses." Services provided by the Company's utilities are subject to regulation by multiple state utility commissions or other entities engaged in utility regulation, collectively referred to as public utility commissions ("PUCs"). The Company also operates market-based businesses that provide complementary water, wastewater and other services to residential and smaller commercial customers, theU.S. government on military installations, as well as municipalities, utilities and industrial customers, collectively presented as the "Market-Based Businesses." These Market-Based Businesses are not subject to economic regulation by state PUCs. See Part I, Item 1-Business in the Company's Form 10-K for additional information. Novel Coronavirus (COVID-19) Pandemic UpdateAmerican Water continues to monitor the global outbreak of the current novel coronavirus ("COVID-19") pandemic and is taking steps to mitigate potential risks to the Company.American Water has three main areas of focus as part of its response to COVID-19: the care and safety of its employees; the safety of its customers and the communities it serves; and the execution of its business continuity plan.American Water is also working with its vendors to understand the potential impacts to its supply chain, and, at this time, it does not anticipate any material negative impacts to its supply chain.American Water is also monitoring impacts of the pandemic on its access to the capital markets, and to the extent such access is adversely affected,American Water may need to consider alternative sources of funding for its operations and for working capital, any of which could increase its cost of capital. In response to these events to address liquidity needs, the Company has taken the steps outlined below in "Recent Financing Activities" and further discussed in "Liquidity and Capital Resources." This pandemic is a rapidly evolving situation, andAmerican Water continues to monitor developments affecting its employees, customers, contractors and vendors and take additional precautions as may be warranted. To date, the Company has experienced COVID-19 financial impacts, including an increase in uncollectible accounts expense, additional debt costs, and certain incremental operation and maintenance ("O&M") expenses. The Company has also experienced decreased revenues as a result of the waiver of late fees, foregone reconnect fees, and lower base revenues, primarily from the Company's commercial and industrial customers, partially offset by increased revenues from the Company's residential customers. See Note 3-Impact of Novel Coronavirus (COVID-19) Pandemic in the Notes to Consolidated Financial Statements for additional information. The extent to which COVID-19 may further impactAmerican Water , including without limitation, its liquidity, financial condition, and results of operations, will depend on future developments, which presently are highly uncertain and cannot be predicted. The Company requested authorization for deferred accounting of COVID-19 financial impacts in all 14 regulatory jurisdictions in which it operates. As ofAugust 5, 2020 ,American Water has commission orders authorizing deferred accounting for COVID-19 financial impacts in ten of 14 jurisdictions, with four requests pending. In addition to approving deferred accounting, two regulatory jurisdictions have also approved cost recovery mechanisms for COVID-19 financial impacts, as presented in the table below: Commission Orders Description States Allowed Regulatory assets Allows the Company to establish regulatory assets to record certain financial impacts related to the COVID-19 CA, HI, IA, IL, IN, pandemic. MD, NJ, PA, VA, WV Cost recovery mechanisms California's Catastrophic Event Memorandum Account CA, IL allows the Company to track and recover certain financial impacts related to the COVID-19 pandemic. Illinois has authorized cost recovery of COVID-19 financial impacts through a special purpose rider over a 24-month period. 25
-------------------------------------------------------------------------------- Table of Contents Consistent with these regulatory orders, the Company recorded$14 million in regulatory assets and$2 million of regulatory liabilities for financial impacts related to the COVID-19 pandemic on the Consolidated Balance Sheets as ofJune 30, 2020 . Recent Financing Activities As a result of the COVID-19 pandemic and to ensure adequate liquidity, onMarch 20, 2020 ,American Water andAmerican Water Capital Corp. ("AWCC"), a wholly owned finance subsidiary ofAmerican Water , entered into a Term Loan Credit Agreement that provides for a term loan facility of up to$750 million (the "Term Loan Facility"). OnMarch 20, 2020 , AWCC borrowed$500 million under the Term Loan Facility, the proceeds of which were used for general corporate purposes of AWCC andAmerican Water , and to provide additional liquidity. The Term Loan Facility allowed for a single additional borrowing of up to$250 million , which expired unused onJune 19, 2020 . See Note 8-Short-Term Debt in the Notes to Consolidated Financial Statements for additional information. OnApril 14, 2020 , AWCC completed a$1.0 billion debt offering which included the sale of$500 million aggregate principal amount of its 2.80% senior notes due 2030 and$500 million aggregate principal amount of its 3.45% senior notes due 2050. Net proceeds of this offering were used to lend funds to parent company and its regulated subsidiaries, repay various senior notes and regulated subsidiary debt obligations at maturity, repay commercial paper obligations and short-term indebtedness under AWCC's unsecured revolving credit facility, and for general corporate purposes. See Note 7-Long-Term Debt in the Notes to Consolidated Financial Statements for additional information. Financial Results For the three and six months endedJune 30, 2020 , diluted earnings per share were$0.97 and$1.65 , respectively, an increase of$0.03 and$0.09 per diluted share, respectively, as compared to the prior year. These increases were primarily driven by continued growth in the Regulated Businesses from infrastructure investment, acquisitions and organic growth, as well as the benefit related to depreciation expense not recorded during 2020 on the assets of the Company'sNew York subsidiary, as required by assets held for sale accounting. Partially offsetting these increases were impacts from the COVID-19 pandemic, primarily from a net decrease in revenues in the Regulated Businesses and some delay in new partner relationships and launch of new products in theHomeowner Services Group ("HOS"). Additionally, during the first quarter of 2019, the Company recorded a$4 million pre-tax benefit from the reduction of the liability related to theFreedom Industries chemical spill settlement inWest Virginia . See "Segment Results of Operations" below for additional information. Growth-through capital investment in infrastructure and regulated acquisitions, as well as strategic growth opportunities in the Market-Based BusinessesThe Company expects to continue to grow its businesses, with the majority of its growth to be achieved in the Regulated Businesses through (i) continued capital investment in the Company's infrastructure to provide safe, clean, reliable and affordable water and wastewater services to its customers, and (ii) regulated acquisitions to expand the Company's services to new customers. The Company also expects to continue to grow the Market-Based Businesses, which leverages its core water and wastewater competencies. During the first six months of 2020, the Company invested$930 million , primarily in the Regulated Businesses, as discussed below: Regulated Businesses Growth •$881 million capital investment in the Regulated Businesses, the majority for infrastructure improvements and replacements. •$40 million to fund acquisitions in the Regulated Businesses, which added approximately 10,700 water and wastewater customers through the six months endedJune 30, 2020 . DuringJuly 2020 , the Company closed on the acquisition of one regulated water system, adding approximately 100 customers. As ofAugust 5, 2020 , the Company has entered into agreements for pending acquisitions in the Regulated Businesses to add approximately 43,600 additional customers. The Company plans to invest approximately$1.9 billion as planned across its footprint in 2020. 26 -------------------------------------------------------------------------------- Table of ContentsSale of New York American Water Company, Inc. OnNovember 20, 2019 , the Company and the Company'sNew York subsidiary entered into a Stock Purchase Agreement (the "Stock Purchase Agreement") withLiberty Utilities Co. ("Liberty"), pursuant to which Liberty will purchase all of the capital stock of theNew York subsidiary (the "Stock Purchase") for an aggregate purchase price of approximately$608 million in cash, subject to adjustment as provided in the Stock Purchase Agreement. The Company's regulatedNew York operations have approximately 125,000 customer connections in theState of New York . Algonquin Power & Utilities Corp., Liberty's parent company, executed and delivered an absolute and unconditional guaranty of the performance of the obligations of Liberty under the Stock Purchase Agreement. The Stock Purchase is subject to various conditions, including obtaining regulatory approval and satisfying or waiving other closing conditions. The Stock Purchase Agreement may be terminated by either party if the Stock Purchase is not completed byJune 30, 2021 , subject to extension for up to six months if all of the conditions to closing have been met, other than obtaining regulatory approvals. Liberty may also terminate the Stock Purchase Agreement if any governmental authority initiates a condemnation or eminent domain proceeding against a majority of the consolidated properties of theNew York subsidiary, taken as a whole. Progress toward completion of the transaction continues, and subject to such closing conditions and no exercise of termination rights, the Company estimates that the Stock Purchase will be completed in early 2021. Accordingly, the assets and related liabilities of theNew York subsidiary were classified as held for sale on the Consolidated Balance Sheets as ofJune 30, 2020 . See Note 5-Acquisitions and Divestitures in the Notes to Consolidated Financial Statements for additional information. Operational Excellence The Company continues to strive for industry-leading operational efficiency. The Company's focus is aimed at enhancing its customer experience and operational efficiency, largely through the use of technology. The Company's adjusted regulated O&M efficiency ratio, which is used as a measure of the operating performance of the Regulated Businesses, was 34.3% for the twelve months endedJune 30, 2020 , as compared to 35.2% for the twelve months endedJune 30, 2019 . The improvement in this ratio reflects the continued focus on operating costs, as well as an increase in operating revenues for the Regulated Businesses. The Company's adjusted regulated O&M efficiency ratio is a non-GAAP measure, and is defined as its operation and maintenance expenses from the Regulated Businesses, divided by the operating revenues from the Regulated Businesses, where both operation and maintenance expenses and operating revenues were adjusted to eliminate purchased water expense. Also excluded from operation and maintenance expenses are the allocable portion of non-operation and maintenance support services costs, mainly depreciation and general taxes, which are reflected in the Regulated Businesses segment as operation and maintenance expenses, but for consolidated financial reporting purposes, are categorized within other line items in the accompanying Consolidated Statements of Operations. The items discussed above were excluded from the O&M efficiency ratio calculation as they are not reflective of management's ability to increase the efficiency of the Regulated Businesses, and in preparing operating plans, budgets and forecasts and in assessing historical performance, management relies, in part, on trends in the Company's historical results, exclusive of these items. The Company evaluates its operating performance using this ratio, and believes it is useful to investors because it directly measures improvement in the operating performance and efficiency of the Regulated Businesses. This information is derived from the Company's consolidated financial information but is not presented in its financial statements prepared in accordance with accounting principles generally accepted inthe United States ("GAAP"). This information supplements and should be read in conjunction with the Company's GAAP disclosures, and should be considered as an addition to, and not a substitute for, any GAAP measure. The Company's adjusted regulated O&M efficiency ratio is not an accounting measure that is based on GAAP, may not be comparable to other companies' operating measures and should not be used in place of the GAAP information provided elsewhere in this Form 10-Q. 27 -------------------------------------------------------------------------------- Table of Contents Presented in the table below is the calculation of the Company's adjusted regulated O&M efficiency ratio and a reconciliation that compares operation and maintenance expenses and operating revenues, each as determined in accordance with GAAP, to those amounts utilized in the calculation of its adjusted O&M efficiency ratio: For the Twelve Months Ended June 30, (Dollars in millions) 2020 2019 Total operation and maintenance expenses $ 1,581$ 1,520
Less:
Operation and maintenance expenses-Market-Based Businesses 384 387 Operation and maintenance expenses-Other (17) (48) Total operation and maintenance expenses-Regulated Businesses 1,214 1,181
Less:
Regulated purchased water expenses 142 132 Allocation of non-operation and maintenance expenses 30 33
Adjusted operation and maintenance expenses-Regulated Businesses (i) $
1,042$ 1,016 Total operating revenues $ 3,690$ 3,521 Less: Operating revenues-Market-Based Businesses 533 528 Operating revenues-Other (20) (22) Total operating revenues-Regulated Businesses 3,177 3,015
Less:
Regulated purchased water revenues (a) 142 132 Adjusted operating revenues-Regulated Businesses (ii) $ 3,035$ 2,883 Adjusted O&M efficiency ratio-Regulated Businesses (i) / (ii) 34.3 % 35.2 %
(a)The calculation assumes regulated purchased water revenues approximate regulated purchased water expenses.
28 -------------------------------------------------------------------------------- Table of Contents Regulatory Matters Presented in the table below are annualized incremental revenues, assuming a constant water sales volume, resulting from general rate cases authorizations that became effective: During the Three Months During the Six Ended June 30, Months Ended (In millions) 2020 June 30, 2020 General rate cases by state: Indiana (a)$ 13 $ 13 California (b) - 5 Total general rate cases$ 13 $ 18 Infrastructure surcharges by state: New Jersey (effective January 1, 2020 and June 29, 2020)$ 10 $ 20 Missouri (effective June 27, 2020) 10 10 Pennsylvania (effective January 1, 2020 and April 1, 2020) 5 15 Tennessee (c) 2 2 Illinois (effective January 1, 2020) - 7 West Virginia (effective January 1, 2020) - 3 Total infrastructure surcharges $
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(a)The Company'sIndiana subsidiary filed for and, onMay 4, 2020 , received approval to implement a$13 million increase for the second rate year, effectiveMay 1, 2020 . (b)The Company'sCalifornia subsidiary filed for the third year (2020) step increase requesting$5 million associated with its most recent general case authorization. The$5 million request was approved and the step rates became effective onJanuary 1, 2020 . (c)The Company's Tennessee subsidiary received approval onMay 11, 2020 , for infrastructure surcharges for annualized incremental revenues of$2 million , effectiveJanuary 1, 2020 . Directly related to the COVID-19 pandemic and its impacts on various processes, onMarch 25, 2020 , theNew York State Public Service Commission approved the Company'sNew York subsidiary's request to postpone the subsidiary's previously approved step increase, originally scheduled to go into effectApril 1, 2020 . Per the order, the rate increase will be postponed for five months untilSeptember 1, 2020 , at which time the previously approved step increase will go into effect. The order further provides a make whole provision to recover the delayed revenues with no earnings impact. In addition to the rate increase postponement, the System Improvement Charge, normally scheduled to go into effectAugust 1, 2020 , will also be postponed untilSeptember 1, 2020 . The rate increase postponement is applicable to all customers, including residential and commercial customers and fire service and irrigation accounts. EffectiveJuly 1, 2020 , the Company'sPennsylvania andKentucky subsidiaries implemented infrastructure surcharges for annualized incremental revenues of$4 million and$1 million , respectively. Pending General Rate Case Filings OnJune 30, 2020 , the Company'sMissouri subsidiary filed a general rate case requesting$78 million in annualized incremental revenues. OnApril 29, 2020 , the Company'sPennsylvania subsidiary filed a general rate case requesting$92 million and$46 million in annualized incremental revenues for rate year 1 and rate year 2, respectively. OnMay 28, 2020 , theOffice of Consumer Advocate filed a motion seeking an extension of the latest date new rates may become effective, and onJune 4, 2020 , the administrative law judge issued an order extending the statutory suspension period by 45 days fromJanuary 28, 2021 toMarch 4, 2021 . OnJune 24, 2020 , the Company'sPennsylvania subsidiary filed a petition for reconsideration of this order. OnDecember 16, 2019 , the Company'sNew Jersey subsidiary filed a general rate case requesting$88 million in annualized incremental revenues. 29 -------------------------------------------------------------------------------- Table of Contents OnJuly 1, 2019 , the Company'sCalifornia subsidiary filed a general rate case requesting$26 million annualized incremental revenues for 2021, and increases of$10 million and$11 million in the escalation year of 2022 and the attrition year of 2023, respectively. OnOctober 11, 2019 , the Company filed its 100 day update for the same proceeding and updated the request to$27 million annualized incremental revenues for 2021, and increases of$10 million and$10 million in the escalation year of 2022 and the attrition year of 2023, respectively. Directly related to the COVID-19 pandemic, theCalifornia Public Utilities Commission ("CPUC") suspended the procedural schedule in the general rate case and directed the parties to participate in an alternative dispute resolution process and provide a joint status conference statement byNovember 15, 2020 . OnJanuary 22, 2020 , the Company'sCalifornia subsidiary submitted a request to delay by one year its cost of capital filing and maintain its current authorized cost of capital through 2021. OnMarch 12, 2020 , theCalifornia Public Utilities Commission granted the request for a one year extension of the cost of capital. The current cost of capital parameters will remain unchanged in 2021 and the subsidiary may file a new cost of capital application byMay 1, 2021 , to adjust its authorized cost of capital beginningJanuary 1, 2022 . In 2018, the Company'sVirginia subsidiary filed a general rate case requesting$5 million in annualized incremental revenues. OnMay 1, 2019 , interim rates under bond and subject to refund were implemented and will remain in effect until a final decision is received on this general rate case filing. There is no assurance that all or any portion of these requests will be granted. Pending Infrastructure Surcharge Filings Presented in the table below are the Company's pending infrastructure surcharge filings: (In millions) Date Filed Amount Pending infrastructure surcharge filings by state: West Virginia June 29, 2020$ 4 New York May 29, 2020 1 Total pending infrastructure surcharge filings$ 5 There is no assurance that all or any portion of these requests will be granted. Tax Matters InMarch 2020 , the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") was signed into law. The CARES Act includes certain tax relief provisions applicable to the Company including: (i) the immediate refund of the corporate alternative minimum tax credit; (ii) the ability to carryback net operating losses for five years for tax years 2018 through 2020; and (iii) delayed payment of employer payroll taxes. The Company is still evaluating the impact of the CARES Act, but it does not expect the CARES Act to have a material impact on the Company's Consolidated Financial Statements. Legislative Updates During 2020, the Company's regulatory jurisdictions enacted the following legislation that has been approved and is effective as ofAugust 5, 2020 : •Indiana House Enrolled Act 1131 establishes an appraisal process for non-municipal utilities to establish fair value and creates a presumption that the appraised value is a reasonable purchase price. Additionally, all new municipal systems will now be regulated for 10 years. •Indiana Senate Enrolled Act 254 authorizes recovery without a full rate case for service enhancements for health, safety or environmental concerns for above ground infrastructure, and exempts relocation from distribution system improvement charge recovery caps. •West Virginia Senate Bill 551 allows for expanded asset valuation, combined water and wastewater ratemaking and the expansion of how municipalities can utilize proceeds from the sale of a water or wastewater system. •Iowa amended HF2452 legislation, which gives the Iowa Utilities Board 180 days to approve acquisitions and allows systems to qualify as a distressed system when they do not have a certified operator. 30 -------------------------------------------------------------------------------- Table of Contents During 2020, the Company's regulatory jurisdictions enacted the following legislation that has been approved but is not yet effective as ofAugust 5, 2020 : •Missouri House Bill 2120 requires most small community water utilities to establish a cyber security plan and valve and hydrant inspection program with reporting to theDepartment of Natural Resources certifying compliance with these provisions upon request. •Virginia Senate Bill 831 establishes fair market value for the state, and the legislation authorizes a water or sewer public utility acquiring a water or sewer system to elect to have its rate base established by using the fair market value. InJuly 2020 , the CPUC released a proposed decision under its Low-Income Rate Payer Assistance program rulemaking, which if adopted would require the Company'sCalifornia subsidiary to file a proposal to alter its water revenue adjustment mechanism in its next general rate case filing in 2022, which would become effective inJanuary 2024 . The Company'sCalifornia subsidiary provided comments on the proposed decision onJuly 27, 2020 . The CPUC will consider the proposed decision no earlier thanAugust 6, 2020 . Condemnation and Eminent Domain All or portions of the Regulated Businesses' utility assets could be acquired by state, municipal or other government entities through one or more of the following methods: (i) eminent domain (also known as condemnation); (ii) the right of purchase given or reserved by a municipality or political subdivision when the original certificate of public convenience and necessity (a "CPCN") was granted; and (iii) the right of purchase given or reserved under the law of the state in which the utility subsidiary was incorporated or from which it received its CPCN. The acquisition consideration related to such a proceeding initiated by a local government may be determined consistent with applicable eminent domain law, or may be negotiated or fixed by appraisers as prescribed by the law of the state or in the particular CPCN. As such, the Regulated Businesses are periodically subject to condemnation proceedings in the ordinary course of business. For example, a citizens group inMonterey, California successfully added "Measure J" to theNovember 2018 election ballot asking voters to decide whether theMonterey Peninsula Water Management District (the "MPWMD") should conduct a feasibility study concerning the potential purchase of theMonterey water service system assets (the "Monterey system assets") of the Company'sCalifornia subsidiary, and, if feasible, to proceed with a purchase of those assets without an additional public vote. This service territory represents approximately 40,000 customers. InNovember 2018 , Measure J was certified to have passed. OnAugust 19, 2019 , the MPWMD's General Manager issued a report that recommends that the MPWMD board (1) develop criteria to determine which water systems should be considered for acquisition, (2) examine the feasibility of acquiring theMonterey system assets and consider public ownership of smaller systems only if the MPWMD becomes the owner of a larger system, (3) evaluate whether it is in the public interest to acquire theMonterey system assets and sufficiently satisfy the criterion of "feasible" as provided in Measure J, (4) ensure there is significant potential for cost savings before agreeing to commence an acquisition, and (5) develop more fully alternate operating plans before deciding whether to consider a Resolution of Necessity. OnNovember 6, 2019 , the MPWMD issued a preliminary valuation and cost of service analysis report, finding in part that (1) an estimate of theMonterey system assets' total value plus adjustments would be approximately$513 million , (2) the cost of service modeling results indicate significant annual reductions in revenue requirements and projected monthly water bills, and (3) the acquisition of theMonterey system assets by the MPWMD would be economically feasible. OnJune 12, 2020 , the MPWMD issued a draft environmental impact report for the potential acquisition of theMonterey system assets and a related district boundary adjustment that would be required if the MPWMD were to acquire and operate certain of theMonterey system assets located outside the MPWMD's boundaries. Comments on the draft report are dueAugust 3, 2020 . If the MPWMD were to make a final determination that an acquisition of theMonterey system assets is feasible, a multi-year eminent domain proceeding against the Company'sCalifornia subsidiary would need to be commenced by the MPWMD to first establish its right to take theMonterey system assets and, if such right is established, to determine the amount of just compensation to be paid to theCalifornia subsidiary for such assets. Also, five municipalities in theChicago, Illinois area (approximately 30,300 customers in total) formed a water agency and filed an eminent domain lawsuit against the Company'sIllinois subsidiary inJanuary 2013 , seeking to condemn the water pipeline that serves those five municipalities. Before filing its eminent domain lawsuit, the water agency made an offer of$38 million for the pipeline. The parties have filed with the court updated valuation reports. A valuation trial to establish the value of the pipeline has been scheduled for the week ofDecember 14, 2020 . 31
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Table of Contents Furthermore, the law in certain jurisdictions in which the Regulated Businesses operate provides for eminent domain rights allowing private property owners to file a lawsuit to seek just compensation against a public utility, if a public utility's infrastructure has been determined to be a substantial cause of damage to that property. In these actions, the plaintiff would not have to prove that the public utility acted negligently. InCalifornia , lawsuits have been filed in connection with large-scale natural events such as wildfires. Some have included allegations that infrastructure of certain utilities triggered the natural event that resulted in damage to the property. In some cases, the PUC has allowed certain costs or losses incurred by the utility to be recovered from customers in rates, but in other cases such recovery in rates has been disallowed. Also, the utility may have obtained insurance that could respond to some or all of such losses, although the utility would be at risk for any losses not ultimately subject to rate or insurance recovery or losses that exceed the limits of such insurance. Consolidated Results of Operations Presented in the table below are the Company's consolidated results of operations:
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