Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read together with the Consolidated Financial Statements and the Notes thereto included elsewhere in this Form 10-K. This discussion contains forward-looking statements that are based on management’s current expectations, estimates and projections about our business, operations and financial performance. The cautionary statements made in this Form 10-K should be read as applying to all related forward-looking statements whenever they appear in this Form 10-K. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of a number of factors, including those we discuss under “Forward-Looking Statements,” Item 1A—Risk Factors and elsewhere in this Form 10-K.

Overview

American Water is the largest and most geographically diverse, publicly-traded water and wastewater utility company in the United States, as measured by both operating revenues and population served. We employ approximately 7,100 professionals who provide drinking water, wastewater and other related services to more than 14 million people in 46 states and Ontario, Canada. Our primary business involves the ownership of utilities that provide water and wastewater services to residential, commercial, industrial, public authority, fire service and sale for resale customers, collectively presented as our “Regulated Businesses.” Our utilities operate in approximately 1,600 communities in 16 states in the United States, with approximately 3.4 million active customers to our water and wastewater networks. Services provided by our utilities are generally subject to economic regulation by certain state utility commissions or other entities engaged in utility regulation. We also operate market-based businesses which provide a broad range of related and complementary water, wastewater and other services to residential and smaller commercial customers, the U.S. government on military installations and shale natural gas exploration and production companies, as well as municipalities, utilities and industrial customers, collectively presented as our Market-Based Businesses. See Item 1—Business for additional information.

Financial Results

The following table provides our diluted earnings per share (GAAP) and our adjusted diluted earnings per share (a non-GAAP measure):

	For the Years Ended December 31,
	2018				2017				2016
Diluted earnings per share (GAAP):
Net income attributable to common shareholders	$	3.15			$	2.38			$	2.62
Adjustments:
Gain on sale of Contract Services Group contracts	(0.08		)		—				—
Income tax impact	0.02				—				—
Net adjustment	(0.06		)		—				—
Keystone impairment charge	0.31				—				—
Income tax impact	(0.08		)		—				—
Net loss attributable to noncontrolling interest	(0.01		)		—				—
Net adjustment	0.22				—				—
Freedom Industries settlement and insurance recoveries	(0.11		)		(0.12		)		0.36
Income tax impact	0.03				0.05				(0.14		)
Net adjustment	(0.08		)		(0.07		)		0.22
Early extinguishment of debt at the parent company	—				0.03				—
Income tax impact	—				(0.01		)		—
Net adjustment	—				0.02				—
Impact of re-measurement from the TCJA	0.07				0.70				—
Total net adjustments	0.15				0.65				0.22
Adjusted diluted earnings per share (non-GAAP)	$	3.30			$	3.03			$	2.84

For the year ended December 31, 2018, diluted earnings per share (GAAP) were $3.15, an increase of $0.77 per diluted share, or 32.4% compared to the prior year, which includes the net adjustments presented in the table above and discussed in greater detail in the “Adjustments to GAAP” section below.

Excluding the net adjustments presented in the table above, adjusted diluted earnings per share (non-GAAP) were $3.30 for the year ended December 31, 2018, an increase of $0.27 per diluted share, or 8.9% compared to the prior year.

These results were driven by continued growth in our Regulated Businesses from infrastructure investment, acquisitions and organic growth, combined with strong results in our Market-Based Businesses, primarily in our Homeowner Services Group with the mid-year acquisition of Pivotal. These increases were partially offset by higher O&M and depreciation expenses from the growth of the business and a lower tax shield on interest expense at the parent company resulting from the TCJA.

For the year ended December 31, 2017, diluted earnings per share (GAAP) were $2.38 per diluted share, a decrease of $0.24 per diluted share, or 9.2% compared to the prior year, which includes the net adjustments presented in the table above and discussed in greater detail in the “Adjustments to GAAP” section below.

Excluding the net adjustments presented in the table above, adjusted diluted earnings per share (non-GAAP) were $3.03 for the year ended December 31, 2017, an increase of $0.19 per diluted share, or 6.7% compared to the prior year.

These results were driven by continued growth in our Regulated Businesses from infrastructure investment, acquisitions and organic growth, combined with growth in our Market-Based Businesses from our Homeowner Services Group and Keystone. These increases were partially offset by lower water services demand in our Regulated Businesses and lower capital upgrades in our Military Services Group.

Adjustments to GAAP

Adjusted diluted earnings per share represents a non-GAAP financial measure and is calculated as GAAP diluted earnings per share, excluding the impact of one or more of the following events: (i) a gain in the third quarter of 2018 on the sale of the majority of our Contract Services Group’s O&M contracts; (ii) a goodwill and intangible impairment charge in the third quarter of 2018 resulting from narrowing the scope of the Keystone business; (iii) insurance settlements received in the third quarter of 2017 and the second quarter of 2018 related to the Freedom Industries chemical spill in West Virginia; (iv) non-cash re-measurement charges recorded in the fourth quarters of 2017 and 2018 resulting from the impact of the change in the federal corporate income tax rate on the Company’s deferred income taxes from the enactment of the TCJA; (v) an early extinguishment of debt charge at the parent company in the third quarter of 2017; and (vi) a charge in the fourth quarter of 2016 related to the binding global agreement in principle to settle claims related to the Freedom Industries chemical spill.

We believe that this non-GAAP measure provides investors with useful information by excluding certain matters that may not be indicative of our ongoing operating results, and that providing this non-GAAP measure will allow investors to understand better our businesses’ operating performance and facilitate a meaningful year-to-year comparison of our results of operations. Although management uses this non-GAAP financial measure internally to evaluate our results of operations, we do not intend results excluding the adjustments to represent results as defined by GAAP, and the reader should not consider them as indicators of performance. This non-GAAP financial measure is derived from our consolidated financial information and it should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP. In addition, this non-GAAP financial measure as defined and used above may not be comparable to similarly titled non-GAAP measures used by other companies, and, accordingly, it may have significant limitations on its use.

Achievements and Strategic Focus

We believe our success has, and will continue to be, guided by the following strategic philosophies:

•	Purpose Driven—“We keep life flowing” is our trademark purpose, for our customers and our communities, because we provide the most precious of life’s critical needs.

•	People Powered—A company is its people. People who have a safe place to work, both physically and emotionally.

•	Customer Obsessed—Without customers, we don’t exist. They are why we are here.

•	Trusted Source of Everything Water— Best in class, ensuring we have safe, reliable and affordable water.

Our strategy, which is driven by our vision and values, will continue to be anchored on our five central themes:

•	Safety—Safety is both a strategy and a value at American Water. We put safety first in everything that we do.

•	In 2018, we:

•	finished the year with fewer employee injuries than the prior year, improving both our Occupational Safety and Health Administration Recordable Incident Rate (“ORIR”) and Days Away, Restricted or Transferred (“DART”) injury severity rate;

•	continued to strengthen our safety culture as measured by employee responses to safety-related questions in the Company’s culture survey, and feedback from our in-person, labor-management conferences;

•	initiated a frontline safety leadership strategic action group, developed to provide recommendations to improve safety leadership training, tools, and engagement; and

•	championed, through our safety council which consists of management and labor employees, our annual Safety Day, the CEO Safety Award and other recognition programs.

•	Looking forward, we will:

•	strive toward zero workplace incidents and eliminate hazards to reduce the potential for incidents;

•	continue our focus on “near miss reporting” and promoting continuous learning and corrective action regarding potential safety hazards before incidents can occur;

•	improve toward the achievement of our ORIR and DART targets;

•	continue our focus on requiring contractors that perform work for the Company be held to the same safety standards as our employees; and

•	continue to promote the Company’s employee Stop Work Authority, where every employee is empowered to stop any work he or she perceives as unsafe, and to initiate a review to resolve concerns and to eliminate safety hazards.

•	Customer—Our customers are at the center of everything we plan and do. Customer input, their ideas and experiences will drive how we improve our processes and systems. We want to be the best, and if our customers have a choice as to who serves them, we want it to be us.

•	In 2018, we:

•	achieved a customer satisfaction rating in the top quartile among our industry peer group;

•	expanded our customer experience initiative, designed to make it easier for customers to do business with us, and enhanced our quality of service through implementation and upgrades of technology tools; and

•	continued to make needed infrastructure investments while implementing operational efficiency improvements to keep customer bills affordable.

•	Looking forward, we will:

•

aim to achieve customer satisfaction and service quality ratings in the top quartile of service industries beyond the water and wastewater industry. We are implementing a multi-year plan to enhance technology and innovation in our customer experience through (i) leveraging secure artificial intelligence to better serve our customers, (ii) using online customer communities for immediate input and reactions before implementing programs, and (iii) mapping our most frequent customer interactions and re-working our internal processes to how customers want services; and

•	aim for top quartile ratings for drinking water quality and being an industry leader in system resiliency and environmental stewardship.

•	People—We are building an inclusive, diverse, fully-engaged, high performance workforce and culture, creating an environment where our people feel valued, included and accountable.

•	In 2018, we:

•	continued to demonstrate our commitment to employees by expanding training and development across the Company, with virtually all employees completing at least 20 hours of formal training during 2018;

•	expanded the executive leadership team to include key operational leaders across the Company to enable a broader operational focus and stronger communication throughout the organization;

•	reached a new, five-year national benefits agreement with approximately 3,200 of our union-represented employees, including their participation in the Company’s annual performance plan, which will align Company goals across all employees, as well as providing additional medical plan options for our employees and their families; and

•	simplified our performance management process to foster meaningful feedback conversations and ensure feedback is the focus of performance management.

•	Looking forward, we will:

•	implement a strategic workforce plan which will address the changing requirements of our business and our jobs, largely driven by our customer’s expectations and new technologies;

•	continue to improve inclusion and diversity of our overall employee population, ensuring our workforce is reflective of the customers and communities we serve;

•	implement a new and more frequent culture survey focused on employee insights into how American Water can become a better company to work for, and to implement recommendations with the goal of increasing employees’ likelihood to recommend American Water as a place to work; and

•	leverage technology to ensure our employees have the tools and resources they need to keep the customer at the center of everything that we plan and do.

•

Growth—We expect to continue to grow our businesses, with the majority of our growth to be achieved in our Regulated Businesses through (i) continued capital investment in our infrastructure to provide safe, clean, reliable and affordable water and wastewater services to our customers, and (ii) regulated acquisitions to expand our services to new customers. We also expect to continue to grow our Market-Based Businesses, which leverage our core water and wastewater competencies.

•	In 2018, we invested $2.0 billion in our Regulated Businesses and Market-Based Businesses.

Regulated Businesses Growth

•	$1.5 billion capital investment in our Regulated Businesses, the majority for infrastructure improvements and replacements.

•	$33 million to fund acquisitions in our Regulated Businesses, which added approximately 14,000 water and wastewater customers.

•	Entered into agreements as of January 31, 2019 for pending acquisitions to add approximately 61,000 customers including:

•	On May 30, 2018, our Pennsylvania subsidiary entered into an agreement to acquire the wastewater assets of Exeter Township, Pennsylvania, for approximately $96 million. This system currently serves approximately 9,000 customers. We are expecting to close this acquisition during the third quarter of 2019, pending regulatory approval.

•

On April 13, 2018, our Illinois subsidiary entered into an agreement to acquire the City of Alton, Illinois’ regional wastewater system for approximately $54 million. This system currently represents approximately 23,000 customers, comprised of approximately 11,000 customers in Alton and an additional 12,000 customers under bulk contracts in the nearby communities of Bethalto and Godfrey. In connection with the execution of the purchase agreement, our Illinois subsidiary made a $5 million non-escrowed deposit to the seller during January 2019. We are expecting to close this acquisition during the second quarter of 2019, pending regulatory approval.

Market-Based Businesses Growth and Optimization

•	We invested $365 million to acquire Pivotal, a leading provider of home warranty protection products and services for gas, electric and other service lines inside and around a home, heating and cooling systems, and home appliances. Pivotal, which joins our Homeowner Services Group, operates in 18 states with approximately 1.2 million customer contracts at the time of acquisition.

•

Our Military Services Group was awarded a contract for ownership, operation and maintenance of the water and wastewater systems at Fort Leonard Wood in Missouri, effective October 1, 2018. Designated as the U.S. Army’s Maneuver Support Center of Excellence and the home to three U.S. Army schools, Fort Leonard Wood directly and indirectly supports 36,400 jobs across the state of Missouri. The contract award includes estimated revenues of approximately $591 million over a 50-year period, subject to an annual economic price adjustment.

•

On July 5, 2018, we entered into an agreement for the sale of 22 of our Contract Services Group’s 33 O&M contracts to subsidiaries of Veolia Environnement S.A. for $27 million. We closed on the sale of 20 of the 22 contracts during the third quarter of 2018, and expect to close on the sale of the remaining two contracts, subject to customer consents, in the first half of 2019. We will retain four of our O&M contracts due to their proximity to our existing service areas, and expect the majority of our remaining O&M contracts to be sold to other parties, or expire within the next year.

•

As a result of operational and financial challenges encountered in the construction business of Keystone, the Company decided to exit this business line during the third quarter of 2018. This action, along with the exit of the water trucking business line during the first half of 2018, narrowed the scope of the Keystone business going forward, focusing solely on providing water transfer services. These factors prompted the impairment testing of Keystone’s goodwill and customer relationship intangible asset at September 30, 2018, resulting in a non-cash, after-tax, impairment charge of $40 million, net of noncontrolling interest. See Note 8—Goodwill and Other Intangible Assets in the Notes to the Consolidated Financial Statements for additional information.

•	Looking forward, we expect to invest between $8.0 billion to $8.6 billion from 2019 to 2023, including a range of $1.7 billion to $1.8 billion in 2019. Our expected future investment includes:

•	capital investment for infrastructure improvements in our Regulated Businesses of $7.3 billion over the next five years, including $1.6 billion expected in 2019;

•	growth from acquisitions in our Regulated Businesses to expand our water and wastewater customer base of between $600 million to $1.2 billion over the next five years, including a range of $120 million to $240 million expected in 2019; and

•	strategic capital investments of approximately $100 million over the next five years, which consists primarily of intellectual property development and strategic growth opportunities in our Market-Based Businesses.

The following chart depicts the estimated allocation of our expected capital investment for infrastructure improvements in our Regulated Businesses over the next five years, by purpose:

•	Operational Excellence—We continue to strive for industry-leading operational efficiency, driven largely by technology. Our technology investments are aimed at enhancing our customer experience and operational efficiency.

•	In 2018:

•

our Regulated Businesses achieved an adjusted O&M efficiency ratio (a non-GAAP measure) of 35.6% for the year ended December 31, 2018, compared to 35.3% and 36.6% for the years ended December 31, 2017 and 2016, respectively. The unfavorability in our adjusted O&M efficiency ratio in 2018, when compared to 2017, was primarily due to a settlement agreement in our New York subsidiary and higher expenses incurred from the colder weather experienced during the first quarter of 2018. The improvement in our adjusted O&M efficiency ratio in 2017, when compared to 2016, was attributable to both an increase in operating revenues and a decrease in O&M expenses;

•	we worked to decrease costs and deploy capital efficiently, including using trenchless technologies for pipeline rehabilitation and leveraging our buying power and strategic sourcing to drive cost savings;

•	we continued our commitment to water quality and the environment by leveraging new technologies; we now have advanced water quality sensors at all of our major drinking water intake sites and we are automating our reporting and compliance systems; and

•	we implemented other technology tools that will enhance communication, collaboration and mobility to help our employees work safely and efficiently, and enhance the customer experience.

•	Looking forward, we will focus on technology and efficiency to:

•	be the leader in optimizing technology deployment across the water and wastewater industry, with a keen focus on specific, innovative projects that will set us apart from other utilities; aiding us in serving our customers with greater ease, making us safer and helping us operate more efficiently; and

•	achieve our goal of an adjusted O&M efficiency ratio of 31.5% by 2023.

Our adjusted O&M efficiency ratio is defined as the operation and maintenance expenses from our Regulated Businesses, divided by the pro forma operating revenues from our Regulated Businesses, where both operation and maintenance expenses and pro forma operating revenues were adjusted to eliminate purchased water expense. Additionally, from operation and maintenance expenses, we excluded the allocable portion of non-operation and maintenance support services costs, mainly depreciation and general taxes, that are reflected in our Regulated Businesses segment as operation and maintenance expenses, but for consolidated financial reporting purposes, are categorized within other line items in the accompanying Consolidated Statements of Operations.

In addition to the adjustments discussed above, for period-to-period comparability purposes, we have presented the estimated impact of the TCJA on operating revenues for our Regulated Businesses on a pro forma basis for all periods presented prior to January 1, 2018, as if the lower federal corporate income tax rate was in effect for these periods (see Note 7—Regulatory Assets and Liabilities in the Notes to Consolidated Financial Statements for additional information). We also made the following adjustments to our O&M efficiency ratio: (i) excluded from operation and maintenance expenses, the impact of certain Freedom Industries chemical spill settlement activities recognized in 2016, 2017 and 2018; and (ii) excluded from operation and maintenance expenses, the impact of the Company’s January 1, 2018 adoption of Accounting Standards Update 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-Retirement Benefit Cost (“ASU 2017-07”) for 2016, 2017 and 2018. See Note 2—Significant Accounting Policies in the Notes to the Consolidated Financial Statements for additional information. We excluded the items discussed above from the calculation as we believe such items are not reflective of management’s ability to increase the efficiency of our Regulated Businesses.

We evaluate our operating performance using this ratio because we believe it directly measures improvement in the efficiency of our Regulated Businesses. This information is intended to enhance an investor’s overall understanding of our operating performance. Our adjusted O&M efficiency ratio is not an accounting measure that is based on 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-K.

With respect to our adjusted O&M efficiency ratio goal for 2023, we are unable to provide without unreasonable efforts a quantitative reconciliation of each component of this ratio to the most comparable financial measure calculated in accordance with GAAP. In calculating the components of the ratio, certain items that may ultimately be excluded would be reflective of events that cannot be reasonably predicted at this time. The unavailable information would include, among other things, the impact of items currently excluded from the calculation of the components, adjustments for weather conditions that exceed a certain threshold of variability and adjustments for events or circumstances that may not be reflective of ongoing operating results. The probable significance of these items is also presently unknown and cannot be reasonably estimated.

The following table provides the calculation of our adjusted O&M efficiency ratio and a reconciliation that compares operation and maintenance expenses and operating revenues, each as determined in accordance with GAAP, to those amounts utilized in the calculation of our adjusted O&M efficiency ratio:

	For the Years Ended December 31,
(Dollars in millions)	2018				2017				2016
Total operation and maintenance expenses (a)	$	1,479			$	1,369			$	1,499
Less:
Operation and maintenance expenses—Market-Based Businesses	362				337				372
Operation and maintenance expenses—Other (a)	(42		)		(44		)		(38		)
Total operation and maintenance expenses—Regulated Businesses (a)	1,159				1,076				1,165
Less:
Regulated purchased water expenses	133				128				122
Allocation of non-operation and maintenance expenses	31				29				30
Impact of Freedom Industries settlement activities (b)	(20		)		(22		)		65
Adjusted operation and maintenance expenses—Regulated Businesses (i)	$	1,015			$	941			$	948
Total operating revenues	$	3,440			$	3,357			$	3,302
Less:
Pro forma adjustment for impact of the TCJA (c)	—				166				161
Total pro forma operating revenues	3,440				3,191				3,141
Less:
Operating revenues—Market-Based Businesses	476				422				451
Operating revenues—Other	(20		)		(23		)		(20		)
Total operating revenues—Regulated Businesses	2,984				2,792				2,710
Less:
Regulated purchased water revenues (d)	133				128				122
Adjusted operating revenues—Regulated Businesses (ii)	$	2,851			$	2,664			$	2,588
Adjusted O&M efficiency ratio—Regulated Businesses (i) / (ii)	35.6		%		35.3		%		36.6		%

NOTE	The adjusted O&M efficiency ratios previously reported for the years ended December 31, 2017 and 2016, were 33.8% and 34.9%, respectively, which did not include the adjustments for the items discussed in footnotes (a) and (c) below.

(a)	Includes the impact of the Company’s adoption of ASU 2017-07 on January 1, 2018. See Note 2—Significant Accounting Policies in the Notes to Consolidated Financial Statements for additional information.

(b)	Includes the impact of the binding global agreement in principle to settle claims in 2016, and settlements in 2017 and 2018 with two of our general liability insurance carriers in connection with the Freedom Industries chemical spill.

(c)	Includes the estimated impact of the TCJA on operating revenues for our Regulated Businesses for all periods presented prior to January 1, 2018, as if the lower federal corporate income tax rate was in effect for these periods. See Note 7—Regulatory Assets and Liabilities in the Notes to Consolidated Financial Statements for additional information.

(d)	The calculation assumes regulated purchased water revenues approximate regulated purchased water expenses.

Regulatory Matters

General Rate Cases

The following table provides annualized incremental revenues resulting from general rate case authorizations that became effective during 2016 through 2018, assuming a constant water sales volume:

(In millions)	2018				2017				2016
General rate cases by state:
New Jersey (a)	$	40			$	—			$	—
Missouri (effective May 28, 2018, July 22, 2016 and July 20, 2016)	33				—				5
New York (effective April 1, 2018 and June 1, 2017)	5				4				—
Pennsylvania (effective January 1, 2018)	62				—				—
California (b)	10				5				2
Virginia (c)	—				5				—
Iowa (effective March 27, 2017)	—				4				—
Illinois (effective January 1, 2017)	—				25				—
Kentucky (effective August 28, 2016)	—				—				7
West Virginia (effective February 25, 2016)	—				—				18
Indiana (effective January 29, 2016)	—				—				2
Total general rate case authorizations	$	150			$	43			$	34

(a)	The effective date was June 15, 2018. As part of the resolution of the general rate case, our New Jersey customers will receive refunds for the amount of provisional rates implemented as of June 15, 2018 and collected that exceeded the final rate increase, plus interest.

(b)	On December 13, 2018, a settlement in our California subsidiary’s general rate case filing was approved, authorizing rates effective January 1, 2018. In 2017, step rates were effective January 13 through February 2. In 2016, step rates were effective January 1.

(c)	The effective date was May 24, 2017, authorizing the implementation of interim rates as of April 1, 2016.

On February 8, 2019, a settlement in our West Virginia subsidiary’s general rate case filing was approved authorizing additional annualized revenues of $19 million, effective February 25, 2019, exclusive of infrastructure replacement surcharges effective in 2017 and 2018.

On February 5, 2019, a settlement in our Maryland subsidiary’s general rate case filing was approved authorizing additional annualized revenues of $1 million, effective February 5, 2019.

Pending General Rate Case Filings

On November 28, 2018, our Kentucky subsidiary filed a general rate case requesting $20 million in additional annualized revenues.

On November 2, 2018, our Virginia subsidiary filed a general rate case requesting $5 million in additional annualized revenues.

On September 14, 2018, our Indiana subsidiary filed a general rate case requesting $18 million and $21 million in additional annualized revenues in 2019 and 2020, respectively.

Infrastructure Surcharges

A number of states have authorized the use of regulatory mechanisms that permit rates to be adjusted outside of a general rate case for certain costs and investments, such as infrastructure surcharge mechanisms that permit recovery of capital investments to replace aging infrastructure. The following table provides annualized incremental revenues resulting from infrastructure surcharge authorizations that became effective during 2016 through 2018, assuming a constant water sales volume:

(In millions)	2018				2017				2016
Infrastructure surcharges by state:
Missouri (effective December 15, 2018 and December 15, 2017)	$	6			$	6			$	—
Tennessee (effective April 10, 2018, March 14, 2017 and March 15, 2016)	1				2				2
Indiana (effective March 14, 2018, March 22, 2017 and May 4, 2016)	7				8				3
Virginia (effective March 1, 2018)	1				—				—
Illinois (a)	3				—				7
West Virginia (effective January 1, 2018 and January 1, 2017)	3				2				—
New Jersey (b)	—				14				19
Pennsylvania (c)	—				1				28
Total infrastructure surcharge authorizations	$	21			$	33			$	59

(a)	In 2018, the effective date was January 1. In 2016, $1 million was effective January 1 and $6 million was effective August 1.

(b)	In 2017, $10 million was effective June 1 and $4 million was effective December 10. In 2016, $9 million was effective June 1 and $10 million was effective December 1.

(c)	In 2017, the effective date was January 1. In 2016, $11 million, $2 million, $6 million and $9 million were effective January 1, April 1, July 1 and October 1, respectively.

On February 8, 2019, our West Virginia subsidiary received authorization for additional annualized revenues of $2 million from an infrastructure surcharge filing, effective January 1, 2019.

On December 20, 2018, our Illinois subsidiary filed for an infrastructure surcharge requesting $8 million in additional annualized revenues, which will become effective on January 1, 2019.

Pending Infrastructure Surcharge Filings

On November 16, 2018, our Tennessee subsidiary filed for an infrastructure surcharge requesting $2 million in additional annualized revenues.

There is no assurance that all or any portion of these requests will be granted.

Tax Matters

Tax Cuts and Jobs Act

On December 22, 2017, the TCJA was signed into law, which, among other things, enacted significant and complex changes to the Internal Revenue Code of 1986, including a reduction in the federal corporate income tax rate from 35% to 21% as of January 1, 2018, and certain other provisions related specifically to the public utility industry, including continuation of interest expense deductibility, the exclusion from utilizing bonus depreciation and the normalization of deferred income tax. The enactment of the TCJA required a re-measurement of our deferred income taxes that materially impacted our 2017 results of operations and financial position. The portion of this re-measurement related to our Regulated Businesses was substantially offset by a regulatory liability, as we believe it is probable that the deferred income tax excesses created by the TCJA will benefit our regulated customers in future rates. The remaining portion of this re-measurement of the net deferred income tax liability was recorded as a non-cash charge to earnings during the fourth quarter of 2017. During 2018, we continued to gather, assess and evaluate additional guidance and regulations related to the changes related to the TCJA. As a result of this process, we have recorded additional adjustments to finalize our initial 2017 estimates. See Note 14—Income Taxes in the Notes to Consolidated Financial Statements for additional information.

During 2018, the Company’s 14 regulatory jurisdictions began to consider the impacts of the TCJA. The Company has adjusted customer rates to reflect the lower income tax rate in 10 states. In one of those 10 states, a portion of the tax savings is being used to reduce certain regulatory assets. In one additional state, we are using the tax savings to offset additional capital investment and to reduce a regulatory asset. Proceedings in the other three jurisdictions remain pending. With respect to excess accumulated deferred income taxes, regulators in the eight states that have considered the issue have agreed with our overall timeline of passing the excess back to customers beginning no earlier than 2019, when the Company is able to produce the normalization schedule using the average rate assumption method. In one of those states, we will use the amortization of the excess accumulated deferred income taxes to offset future infrastructure investments.

On March 23, 2018, President Trump signed the Consolidated Appropriations Act of 2018 (the “CAA”). The CAA corrects and clarifies some aspects of the TCJA related to bonus depreciation eligibility. Specifically, property that was acquired, or the construction began, prior to September 27, 2017, is eligible for bonus depreciation. This clarification allowed the Company to benefit from additional bonus depreciation deductions on the 2017 tax return, and as a result, we believe that we will likely begin paying federal income taxes towards the end of 2019, when we expect our federal NOL carryforwards balance will be fully used, and expect to be a full year cash taxpayer by 2020, although this timing could be impacted by any significant changes in our future results of operations and the outcome of pending regulatory proceedings regarding the TCJA.

On November 26, 2018, the U.S. Department of the Treasury released proposed regulations concerning interest expense limitation rules. The TCJA revised and broadened the existing interest expense limitation regulations. The Company has considered all the rules set forth in the proposed regulation including allocated interest expense and interest income based on the relative amounts of the Company’s adjusted basis in the assets used in its excepted and non-excepted trades or business, or our Regulated Businesses and Market-Based Businesses. Based on our interpretation of the new guidance, the Company reasonably believes the deductibility of its interest expense will not be limited under the new regulations.

Other Tax Matters

On June 1, 2018, the State of Missouri enacted legislation that decreased the state income tax rate on our taxable income attributable to Missouri from 6.25% to 4.00%, beginning in the 2020 tax year. As a result, we were required to re-measure our cumulative deferred income tax balances using the lower state income tax rate in the second quarter of 2018. This resulted in a decrease to the Company’s unitary deferred income tax liability of $12 million, and an increase to a regulatory liability of $13 million, as we believe it is probable of refund in future rates.

On May 30, 2018, the State of Iowa enacted legislation that decreased the state income tax rate on our taxable income attributable to Iowa from 12.0% to 9.8%, beginning in the 2021 tax year. The deferred income tax liability for our Iowa subsidiary was reduced by $1 million, and offset by a regulatory liability, as we believe this liability is probable of refund in future rates.

On April 13, 2018, the State of Kentucky enacted legislation that decreased the state income tax rate on our taxable income attributable to Kentucky from 6% to 5%, beginning in the 2018 tax year. In addition, beginning in the 2019 tax year, a consolidated return, including all affiliated group members, will be required. As a result, we were required to record a deferred income tax liability of $7 million for our Kentucky unitary filing group, and the existing deferred income tax liability related to our Kentucky subsidiary was reduced by $1 million, offset by a regulatory liability, as we believe this liability is probable of refund in future rates.

The Company performed its annual review of the apportionment rates in all of its unitary filing jurisdictions and implemented changes to reflect considerations for historical results and future business outlooks in each of the jurisdictions. As of December 31, 2018, we recorded a non-cash, cumulative charge to earnings of $12 million, resulting from the legislative changes described above and the adjustments made through various state income tax apportionment rates.

On July 1, 2018, the State of New Jersey enacted legislation that increased the corporate business tax rate from 9.0% to 11.5% for the 2018 and 2019 tax years, and to 10.5% for the 2020 and 2021 tax years. The tax rate will revert back to 9.0% for tax year 2022 and beyond. Additionally, the new legislation states that for the year beginning on and after January 1, 2019, a unitary group will be required to file a combined unitary New Jersey tax return. The legislation allows a deduction over a 10-year period, commencing five years after the enactment of unitary combined reporting, if the combined reporting provisions result in an aggregate increase to the net deferred income tax liability or an aggregate decrease to the net deferred income tax asset. Thus, the deferred income tax liability resulting from the unitary filing requirement would be completely offset by the deferred income tax asset derived from this deduction. There are no underlying impacts to the Company’s earnings as a result of the new filing requirement. On October 4, 2018, New Jersey’s governor signed a technical correction bill into law. The correction bill provides an exclusion for water and wastewater utility companies whose rates are regulated from the combined reporting requirement. The Company’s tax credit granted by the State of New Jersey will not be impacted by the law changes mentioned above.

Legislative Updates

During 2018, our regulatory jurisdictions enacted legislation as follows:

•	House File 2307 in Iowa and House Bill 1566 in Maryland allow a fair market value methodology to be included in rate base with respect to prospective acquisitions.

•	Senate Enrolled Act 362 in Indiana, which, similar to the Water Quality Accountability Act enacted in New Jersey in 2017, sets new operational standards and requirements for water and wastewater treatment plants in areas such as capital asset management, cost-benefit analysis and cybersecurity.

•	Senate Bill 705 in Missouri allows the Missouri Public Service Commission to approve a revenue stability mechanism (“RSM”) for water utilities. In an effort to encourage conservation, a RSM adjusts rates periodically to ensure that a utility’s revenue will be sufficient to cover its costs, and customers will not overpay for service.

•

Senate Bill 592 in Missouri changes the public vote requirement for the sale of a municipal water or wastewater system to a simple majority for more than 500 small towns. Historically, only larger communities required a simple majority, while smaller communities needed a two-thirds majority. This legislation increases the options for small towns, should they decide to address their water and sewer challenges through an asset sale.

•	Legislation was passed in Iowa that allows private water utilities to use a future test year approach in rate cases, decreasing potential regulatory lag and helping to spread out the time between rate cases.

•	In California, Assembly Bill 2179 changed the vote required to allow cities to sell sewer systems to a simple majority as compared to a two-thirds majority, and Assembly Bill 2339 allowed certain cities to sell water systems without an election.

•

Act 58 of 2018 in Pennsylvania allows public utilities to implement alternative rates and rate mechanisms in rate base proceedings. These alternative rates and rate mechanisms include, but are not limited to the following: revenue stability mechanisms, performance-based rates, formula rates, multi-year rate plans, or a combination of those mechanisms or other mechanisms. Petitions to establish alternative rate mechanisms are subject to PUC review and approval and can only be filed by a utility in a rate base proceeding.

•

On October 17, 2018, the Pennsylvania General Assembly passed legislation that allows an investor-owned water utility to include the replacement costs for customer-owned LSLs and customer-owned damaged wastewater laterals in rate base when replaced as part of a Pennsylvania Public Utility Commission approved program. The law became effective December 23, 2018. Prior to the new law, our Pennsylvania subsidiary sought the approval of the Pennsylvania Public Utility Commission to revise the Company’s rules to permit it to replace customer-owned LSLs and to recover associated costs. Our Pennsylvania subsidiary’s proposed replacement of customer-owned LSL program is being reviewed under the provisions of the new law.

•

On October 23, 2018, President Trump signed America’s Water Infrastructure Act of 2018. The legislation includes policies intended to improve water and wastewater system management and authorization for states to assess options for consolidation for systems that do not comply with the federal Safe Drinking Water Act and its rules and regulations. The legislation increases funding to water system funding programs, including the State Revolving Loan Fund program and the Water Infrastructure Finance and Innovation Act.

Consolidated Results of Operations

The following table provides our consolidated results of operations and the ensuing discussions provide explanations for the variances related to the major components:

	For the Years Ended December 31,												Increase (Decrease)							Increase (Decrease)
	2018				2017				2016				2018 vs. 2017							2017 vs. 2016
(Dollars in millions)													$				%			$				%
Operating revenues	$	3,440			$	3,357			$	3,302			$	83			2.5			$	55			1.7
Operating expenses:
Operation and maintenance	1,479				1,369				1,499				110				8.0			(130		)		(8.7	)
Depreciation and amortization	545				492				470				53				10.8			22				4.7
General taxes	277				259				258				18				6.9			1				0.4
(Gain) on asset dispositions and purchases	(20		)		(16		)		(10		)		(4		)		25.0			(6		)		60.0
Impairment charge	57				—				—				57				100.0			—				—
Total operating expenses, net	2,338				2,104				2,217				234				11.1			(113		)		(5.1	)
Operating income	1,102				1,253				1,085				(151		)		(12.1	)		168				15.5
Other income (expense):
Interest, net	(350		)		(342		)		(325		)		(8		)		2.3			(17		)		5.2
Non-operating benefit costs, net	20				(9		)		(5		)		29				322.2			(4		)		80.0
Loss on early extinguishment of debt	(4		)		(7		)		—				3				(42.9	)		(7		)		100.0
Other, net	19				17				15				2				11.8			2				13.3
Total other income (expense)	(315		)		(341		)		(315		)		26				(7.6	)		(26		)		8.3
Income before income taxes	787				912				770				(125		)		(13.7	)		142				18.4
Provision for income taxes	222				486				302				(264		)		(54.3	)		184				60.9
Consolidated net income	565				426				468				139				32.6			(42		)		(9.0	)
Net loss attributable to noncontrolling interest	(2		)		—				—				(2		)		(100.0	)		—				—
Net income attributable to common shareholders	$	567			$	426			$	468			$	141			33.1			$	(42	)		(9.0	)

In 2018, net income attributable to common shareholders increased $141 million, or 33.1 percent, compared to the same period in 2017. This increase was due to a $125 million non-cash charge in 2017 related to the implementation of TCJA, continued growth in the Regulated Businesses, driven by infrastructure investment, acquisitions and organic growth and growth in the Market-Based Businesses, mainly from our Homeowner Services Group due to the mid-year acquisition of Pivotal. These increases were partially offset by higher O&M and depreciation expenses across the Company due to growth of the business and the asset impairment charge recorded for our Keystone subsidiary during the third quarter of 2018.

In 2017, net income attributable to common shareholders decreased $42 million, or 9.0 percent, as compared to the same period in 2016. This decrease was due to a $125 million non-cash charge in 2017 related to the implementation of TCJA resulting from the re-measurement of deferred taxes primarily at the parent company from the reduction in the federal corporate income tax rate from 35% to 21%. Partially offsetting this non-cash charge was continued growth in the Regulated Businesses driven mainly by infrastructure investment, acquisitions and organic growth, combined with growth in the Market-Based Businesses mainly from the Homeowner Services Group and Keystone.

Segment Results of Operations

Our operating segments are comprised of the revenue-generating components of the business for which separate financial information is internally produced and regularly used by management to make operating decisions, assess performance and allocate resources. The Company operates its business primarily through one reportable segment, the Regulated Businesses segment. We also operate several market-based businesses within operating segments that individually do not meet the criteria of a reportable segment in accordance with GAAP. These non-reportable operating segments are collectively presented as our Market-Based Businesses, which is consistent with how management assesses the results of these businesses.

Regulated Businesses Segment

The following table provides financial information for our Regulated Businesses:

	For the Years Ended December 31,												Increase (Decrease)							Increase (Decrease)
	2018				2017				2016				2018 vs. 2017							2017 vs. 2016
(Dollars in millions)													$				%			$				%
Operating revenues	$	2,984			$	2,958			$	2,871			$	26			0.9			$	87			3.0
Operation and maintenance	1,159				1,076				1,165				83				7.7			(89		)		(7.6	)
Depreciation and amortization	500				462				440				38				8.2			22				5.0
General taxes	261				244				242				17				7.0			2				0.8
(Gain) on asset dispositions and purchases	(7		)		(16		)		(7		)		9				(56.3	)		(9		)		128.6
Interest, net	(280		)		(268		)		(256		)		(12		)		4.5			(12		)		4.7
Other income (expenses)	(247		)		(266		)		(257		)		19				(7.1	)		(9		)		3.5
Income before income taxes	826				925				775				(99		)		(10.7	)		150				19.4
Provision for income taxes	224				367				303				(143		)		(39.0	)		64				21.1
Net income attributable to common shareholders	602				559				472				43				7.7			87				18.4

Operating Revenues

The following tables provide provide information regarding the main components of our Regulated Businesses’ operating revenues and the ensuing discussions provide explanation for the material variances:

	For the Years Ended December 31,												Increase (Decrease)							Increase (Decrease)
	2018				2017				2016				2018 vs. 2017							2017 vs. 2016
(Dollars in millions)													$				%			$				%
Water services:
Residential	$	1,663			$	1,644			$	1,601			$	19			1.2			$	43			2.7
Commercial	616				601				582				15				2.5			19				3.3
Fire service	137				139				134				(2		)		(1.4	)		5				3.7
Industrial	136				137				134				(1		)		(0.7	)		3				2.2
Public and other	216				244				259				(28		)		(11.5	)		(15		)		(5.8	)
Total water services	2,768				2,765				2,710				3				0.1			55				2.0
Wastewater services	161				142				112				19				13.4			30				26.8
Other (a)	55				51				49				4				7.8			2				4.1
Total operating revenues	$	2,984			$	2,958			$	2,871			$	26			0.9			$	87			3.0

(a)	Includes other operating revenues consisting primarily of miscellaneous utility charges, fees and rents.

	For the Years Ended December 31,									Increase (Decrease)						Increase (Decrease)
	2018			2017			2016			2018 vs. 2017						2017 vs. 2016
(Gallons in millions)										Gallons			%			Gallons			%
Billed water services volumes:
Residential	172,827			174,420			174,599			(1,593	)		(0.9	)		(179	)		(0.1	)
Commercial	82,572			82,147			82,489			425			0.5			(342	)		(0.4	)
Industrial	38,432			39,404			38,465			(972	)		(2.5	)		939			2.4
Fire service, public and other	50,651			51,341			50,678			(690	)		(1.3	)		663			1.3
Total billed water services volumes	344,482			347,312			346,231			(2,830	)		(0.8	)		1,081			0.3

In 2018, operating revenues increased $26 million, or 0.9%, primarily due to a:

•	$149 million increase from authorized rate increases, including infrastructure surcharges, principally to fund infrastructure investment in various states;

•	$22 million increase from water and wastewater acquisitions, as well as organic growth in existing systems; and

•

$148 million decrease from the impacts of the TCJA which have or are expected to benefit customers. This decrease is made up of two components: (i) a reserve on revenue billed during 2018, for the estimated income tax savings expected to benefit customers in future rates; and (ii) rate adjustments made in certain subsidiaries where our Regulators have authorized lower rates or offsets to regulatory assets or capital investments to pass the benefits to customers.

In 2017, operating revenues increased $87 million, or 3.0%, primarily due to a:

•	$81 million increase from authorized rate increases, including infrastructure surcharges, principally to fund infrastructure investment in various states;

•	$43 million increase from water and wastewater acquisitions, as well as organic growth in existing systems; and

•	$9 million increase from higher wastewater treatment volumes and an increase in private fire service connections; partially offset by a

•	$48 million decrease from lower water services demand, including a $15 million reduction due to warmer weather in 2016.

Operation and Maintenance

The following tables provide information regarding the main components of our Regulated Businesses’ operating and maintenance expense and the ensuing discussions provide an explanation for the material variances:

	For the Years Ended December 31,												Increase (Decrease)						Increase (Decrease)
	2018				2017				2016				2018 vs. 2017						2017 vs. 2016
(Dollars in millions)													$				%		$				%
Production costs	$	313			$	298			$	288			$	15			5.0		$	10			3.5
Employee-related costs	451				431				431				20				4.6		—				—
Operating supplies and services	227				209				212				18				8.6		(3		)		(1.4	)
Maintenance materials and supplies	81				70				73				11				15.7		(3		)		(4.1	)
Customer billing and accounting	60				51				54				9				17.6		(3		)		(5.6	)
Other	27				17				107				10				58.8		(90		)		(84.1	)
Total	$	1,159			$	1,076			$	1,165			$	83			7.7		$	(89	)		(7.6	)

Production Costs

	For the Years Ended December 31,												Increase (Decrease)						Increase (Decrease)
	2018				2017				2016				2018 vs. 2017						2017 vs. 2016
(Dollars in millions)													$				%		$				%
Purchased water	$	133			$	128			$	122			$	5			3.9		$	6			4.9
Fuel and power	91				89				87				2				2.2		2				2.3
Chemicals	52				47				47				5				10.6		—				—
Waste disposal	37				34				32				3				8.8		2				6.3
Total	$	313			$	298			$	288			$	15			5.0		$	10			3.5

In 2018, production costs increased $15 million, or 5.0%, primarily due to a:

•	$5 million increase in purchased water from higher prices in our California subsidiary;

•	$5 million increase in chemicals from higher usage, the result of wet weather conditions in 2018, primarily in the Northeast and Mid-Atlantic; and

•	$3 million increase in waste disposal from higher sludge removal costs, primarily in our New Jersey subsidiary.

In 2017, production costs increased $10 million, or 3.5%, primarily due to a:

•	$6 million increase in purchased water from higher usage in our California subsidiary, the result of the California water usage restrictions, which were mandated in 2015 due to the state’s extreme drought, being lifted in the second quarter of 2017; and

•	$2 million increase in waste disposal from higher sludge removal costs in our Illinois and Missouri subsidiaries.

Employee-Related Costs

	For the Years Ended December 31,												Increase (Decrease)						Increase (Decrease)
	2018				2017				2016				2018 vs. 2017						2017 vs. 2016
(Dollars in millions)													$				%		$				%
Salaries and wages	$	349			$	334			$	336			$	15			4.5		$	(2	)		(0.6	)
Pensions	19				14				18				5				35.7		(4		)		(22.2	)
Group insurance	57				57				56				—				—		1				1.8
Other benefits	26				26				21				—				—		5				23.8
Total	$	451			$	431			$	431			$	20			4.6		$	—			—

In 2018, employee-related costs increased $20 million, or 4.6%, primarily due to a:

•	$15 million increase in salaries and wages to support growth of the business, as well as an increase in overtime related to a higher volume of main breaks during the first quarter of 2018, the result of harshly frigid weather in the Midwest, Northeast and parts of the Mid-Atlantic; and

•	$5 million increase in pensions from an authorized change in regulatory recovery of pension expense in our Pennsylvania subsidiary.

In 2017, employee-related costs remained consistent primarily due to a:

•	$5 million increase in other benefits from higher employer 401(k) savings plan contributions and an increase in training costs; partially offset by a

•	$4 million decrease in pensions from higher capitalization rates in 2017.

Operating Supplies and Services

In 2018, operating supplies and services increased $18 million, or 8.6%, primarily due to a $17 million increase in contracted services from higher costs for various legal matters including a settlement agreement in our New York subsidiary and costs associated with condemnation proceedings in Monterey, California, higher costs from temporary workers as a result of restructuring initiatives in our technology support services, as well as an increase in other operating expenses.

In 2017, operating supplies and services decreased $3 million, or 1.4%, primarily due to a decrease in charges recorded in 2016, including a $5 million write-off of timekeeping system costs that were previously capitalized and a $7 million judgment in litigation, partially offset by an increase in office supplies and services from higher employee relocation, telecommunication and office supplies costs.

Maintenance Materials and Supplies

In 2018, maintenance materials and supplies increased $11 million, or 15.7%, from a higher volume of main breaks and paving costs, driven by the colder weather experienced during the first quarter of 2018, as well as higher tank painting costs in our New Jersey subsidiary and various maintenance projects in our Pennsylvania, Missouri and Indiana subsidiaries.

In 2017, maintenance materials and supplies decreased $3 million, or 4.1%, from lower tank painting costs in our New Jersey subsidiary and the timing of maintenance activities.

Customer Billing and Accounting

In 2018, customer billing and accounting increased $9 million, or 17.6%, from an increase in customer uncollectible expense, primarily in our Pennsylvania, Missouri and New York subsidiaries, and higher call volumes experienced at our customer service centers.

In 2017, customer billing and accounting decreased $3 million or 5.6%, from lower customer uncollectible expense attributable to focused collection efforts.

Other (Operation and Maintenance)

In 2018, other (operation and maintenance) increased $10 million, or 58.8%, primarily due to higher casualty insurance claims in 2018, and a $3 million charge from a regulatory authorization allowing a portion of the income tax savings resulting from the TCJA to be used to reduce certain regulatory assets. During 2018, we recorded a $20 million benefit resulting from an insurance settlement with one of our general liability insurance carriers associated with the Freedom Industries chemical spill in West Virginia.

In 2017, other (operation and maintenance) decreased $90 million, or 84.1%, primarily due to a $65 million net charge recorded in 2016, resulting from the binding global agreement in principle to settle claims associated with the Freedom Industries chemical spill in West Virginia, and a $22 million benefit recorded in 2017, resulting from a related insurance settlement with one of our general liability insurance carriers, as well as a decrease in casualty insurance expense attributable to a lower claims experience in 2017.

Depreciation and Amortization

In 2018 and 2017, depreciation and amortization increased $38 million and $22 million, or 8.2% and 5.0%, respectively. The increase for both periods was primarily due to additional utility plant placed in service.

General Taxes

In 2018 and 2017, general taxes increased $17 million and $2 million, or 7.0% and 0.8%, respectively. The increase in 2018 was primarily due to incremental property taxes in several of our subsidiaries, including in Missouri and New York.

(Gain) on Asset Dispositions and Purchases

In 2018 and 2017, (gain) on asset dispositions and purchases increased $9 million, or 56.3%, and decreased $9 million, or 128.6%, respectively. The decrease in 2018 was primarily due to higher gains recognized in 2017, including a $7 million gain on a land sale in our Kentucky subsidiary, along with acquisition and land sale gains in our Pennsylvania, Missouri and California subsidiaries, partially offset by gains recognized in 2018 for the sale of a treatment plant in our Illinois subsidiary and a building in our New Jersey subsidiary.

Interest, net

In 2018 and 2017, interest, net increased $12 million and $12 million, respectively. The increase in interest expense during 2018 was driven by the issuance of incremental long-term debt in the third quarter of 2018 to support growth of the business, and higher levels of short-term borrowings during 2018, coupled with an increase in the average short-term borrowing rate in the current year. For the year ended December 31, 2017, the increase in interest expense was driven by the issuance of incremental long-term debt in 2017 to support growth of the business.

Other Income (Expenses)

In 2018, other income (expenses) increased $19 million, or 7.1%, primarily due to a reduction in the non-service cost components of pension and other postretirement benefits expense resulting from favorable actuarial performance, and an increase in allowance for funds used during construction attributable to higher capital investment in 2018, partially offset by an increase in interest expense as discussed above. For the year ended December 31, 2017, the increase in other income (expenses) was primarily due to an increase in interest expense as discussed above.

Provision for Income Taxes

For the year ended December 31, 2018, our provision for income taxes decreased primarily due to the reduction in the federal corporate income tax rate from 35% to 21% as of January 1, 2018, resulting from the enactment of the TCJA. We expect the reduced tax rate will benefit our customers through established ratemaking, tax and regulatory normalization provisions. During 2018, we continued assessing the impacts of the TCJA as allowed by Staff Accounting Bulletin 118 (“SAB 118”), and as a result we recorded adjustments to federal and state income tax TCJA estimates. For the year ended December 31, 2017, our provision for income taxes increased primarily due to higher pretax income in 2017 compared to 2016.

Market-Based Businesses

The following table provides financial information for our Market-Based Businesses and the ensuing discussions provide explanation for the material variances:

	For the Years Ended December 31,												Increase (Decrease)							Increase (Decrease)
	2018				2017				2016				2018 vs. 2017							2017 vs. 2016
(Dollars in millions)													$				%			$				%
Operating revenues	$	476			$	422			$	451			$	54			12.8			$	(29	)		(6.4	)
Operation and maintenance	362				337				372				25				7.4			(35		)		(9.4	)
Depreciation and amortization	29				18				15				11				61.1			3				20.0
(Gain) on asset dispositions and purchases	(13		)		—				(1		)		(13		)		(100.0	)		1				(100.0	)
Impairment charge	57				—				—				57				100.0			—				—
Income before income taxes	41				66				65				(25		)		(37.9	)		1				1.5
Provision for income taxes	11				28				26				(17		)		(60.7	)		2				7.7
Net loss attributable to noncontrolling interest	(2		)		—				—				(2		)		(100.0	)		—				—
Net income attributable to common shareholders	32				38				39				(6		)		(15.8	)		(1		)		(2.6	)

Operating Revenues

In 2018, operating revenues increased $54 million, or 12.8%, primarily due to a:

•	$76 million increase in our Homeowner Services Group from contract growth, including $67 million from the acquisition of Pivotal on June 4, 2018; and

•	$6 million increase in Keystone from an increase in water transfer operations resulting from market recovery in the shale natural gas industry; partially offset by a

•	$16 million decrease in our Military Services Group from lower capital upgrades; and

•	$14 million decrease in our Contract Services Group from the sale of the majority of our O&M contracts to subsidiaries of Veolia Environnement S.A. during the third quarter of 2018.

In 2017, operating revenues decreased $29 million, or 6.4%, primarily due to a:

•	$56 million decrease in our Military Services Group from lower capital upgrades, largely driven by reduced military base budgets and the completion of a large project in the first half of 2017 at Fort Polk; and

•	$6 million decrease in our Contract Services Group from the completion of several O&M contracts during 2017; partially offset by a

•	$18 million increase in our Homeowner Services Group from contract growth, as well as expansion into new geographic areas and price increases for existing customers; and

•	$16 million increase in Keystone due to an increase in operations resulting from market recovery in the shale natural gas industry.

Operation and Maintenance

The following table provides information regarding the main components of our Market-Based Businesses’ operating and maintenance expense and the ensuing discussions provide an explanation for the material variances:

	For the Years Ended December 31,												Increase (Decrease)							Increase (Decrease)
	2018				2017				2016				2018 vs. 2017							2017 vs. 2016
(Dollars in millions)													$				%			$				%
Production costs	$	32			$	37			$	35			$	(5	)		(13.5	)		$	2			5.7
Employee-related costs	104				97				94				7				7.2			3				3.2
Operating supplies and services	142				121				165				21				17.4			(44		)		(26.7	)
Maintenance materials and supplies	69				67				68				2				3.0			(1		)		(1.5	)
Other	15				15				10				—				—			5				50.0
Total	$	362			$	337			$	372			$	25			7.4			$	(35	)		(9.4	)

In 2018, operation and maintenance expense increased $25 million, or 7.4%, primarily due to a:

•	$7 million increase in employee-related costs mainly in our Homeowner Services Group related to the acquisition of Pivotal on June 4, 2018, partly offset by lower costs in our Contract Services Group resulting from the sale of the majority of our O&M contracts during the third quarter of 2018; and

•

$21 million increase in operating supplies and services from the acquisition of Pivotal and higher advertising and marketing expense in our Homeowner Services Group, as well as an increase in water transfer operations in Keystone, offset in part by lower capital upgrades in our Military Services Group and the sale of the majority of our Contract Services Group’s O&M contracts during the third quarter of 2018, as discussed above; partially offset by a

•	$5 million decrease in production costs from lower purchased water and chemical usage in our Contract Services Group resulting from the sale of the majority of our O&M contracts during the third quarter of 2018.

In 2017, operation and maintenance expense decreased $35 million, or 9.4%, primarily due to a:

•	$44 million decrease in operating supplies and services from lower capital upgrades in our Military Services Group, as discussed above, as well as lower advertising and marketing expense in our Homeowner Services Group; partially offset by a

•	$3 million increase in employee-related costs from higher headcount in Keystone from an increase in operations, as discussed above, offset in part in our Contract Services Group from the completion of several O&M contracts during 2017; and

•	$5 million increase in other (operating and maintenance expense) from an increase in customer uncollectible expense in our Homeowner Services Group resulting from contract growth in 2017.

Depreciation and Amortization

In 2018 and 2017, depreciation and amortization increased $11 million and $3 million, or 61.1% and 20.0%, respectively. The increase in 2018 was primarily due to the addition of property, plant and equipment and intangible assets from the acquisition of Pivotal on June 4, 2018.

(Gain) on Asset Dispositions and Purchases

In 2018, (gain) on asset dispositions and purchases increased $13 million primarily due to the (gain) recognized on the sale of the majority of our Contract Services Group’s O&M contracts to subsidiaries of Veolia Environnement S.A. during the third quarter of 2018, partially offset by a loss recognized on the sale of property, plant and equipment in Keystone. See Note 4—Acquisitions and Divestitures in the Notes to Consolidated Financial Statements for additional information regarding the Veolia Environnement S.A. transaction.

Impairment Charge

During the third quarter of 2018, a goodwill and intangible asset impairment charge of $57 million was recorded for Keystone, the result of operational and financial challenges encountered in the construction business, and the Company’s determination to narrow the scope of the Keystone business, to focus on its core operations of providing water transfer services. See Note 8—Goodwill and Other Intangible Assets in the Notes to Consolidated Financial Statements for additional information.

Provision for Income Taxes

In 2018 and 2017, provision for income taxes decreased $17 million, or 60.7%, and increased $2 million, or 7.7%, respectively. The decrease in 2018 was primarily due to the reduction in the federal corporate income tax rate from 35% to 21% as of January 1, 2018, resulting from the enactment of the TCJA.

Liquidity and Capital Resources

We regularly evaluate and monitor our cash requirements for capital investments, acquisitions, operations, commitments, debt maturities, interest and dividends. Our business is capital intensive, with a majority of this capital funded by cash flows from operations. When necessary, we also obtain funds from external sources, primarily in the debt markets and through short-term commercial paper borrowings. We also have access to equity capital markets, if needed. Our access to external financing on reasonable terms depends on our credit ratings and current business conditions, including that of the utility and water utility industry in general, as well as conditions in the debt or equity capital markets, and the national and international economic and geopolitical arenas. If these business, market, financial and other conditions deteriorate to the extent that we no longer are able to access the capital markets on reasonable terms, we have access to an unsecured revolving credit facility with aggregate bank commitments of $2.25 billion, with an expiration date of June 2023 (subject to extension by us for up to two one-year periods). We rely on this revolving credit facility and the capital markets to fulfill our short-term liquidity needs, to issue letters of credit and to support our $2.10 billion commercial paper program. Disruptions in the credit markets may discourage lenders from extending the terms of such commitments or agreeing to new commitments. Market disruptions may also limit our ability to issue debt and equity securities in the capital markets. See “Credit Facilities and Short-Term Debt” section below for additional information.

In order to meet our short-term liquidity needs, we, through AWCC, our wholly owned financing subsidiary, issue commercial paper, which is supported by the revolving credit facility. As of December 31, 2018, AWCC had no outstanding borrowings and $81 million of outstanding letters of credit under its revolving credit facility, with $2.25 billion available to fulfill our short-term liquidity needs and to issue letters of credit, which supported $954 million in outstanding commercial paper. We believe that our ability to access the capital markets, our revolving credit facility and our cash flows from operations will generate sufficient cash to fund our short-term requirements. We have no plans to issue equity under normal operating conditions in the foreseeable future with the limited exception of privately or investor-owned acquisitions whose sellers require equity to complete the acquisition or other opportunistic acquisitions. We believe we have sufficient liquidity and the ability to manage our expenditures, should there be a disruption of the capital and credit markets. However, we can provide no assurances that the lenders will meet their existing commitments to AWCC under the revolving credit facility or that we will be able to access the commercial paper or loan markets in the future on terms acceptable to us or at all.

In addition, our Regulated Businesses receive advances and contributions from customers, home builders and real estate developers to fund construction necessary to extend service to new areas. Advances for construction are refundable for limited periods, which vary according to state regulations, as new customers begin to receive service or other contractual obligations are fulfilled. Amounts which are no longer refundable are reclassified to contributions in aid of construction. Utility plant funded by advances and contributions is excluded from our Regulated Businesses rate base. Generally, we depreciate contributed property and amortize contributions in aid of construction at the composite rate of the related property. Some of our subsidiaries do not depreciate contributed property, based upon regulatory guidelines. The taxability of advances and contributions in aid of construction was changed with the enactment of the TCJA. Previously, the majority of advances and contributions that we collected were not taxable; however, with the enactment of the TCJA, they are now treated as taxable income. Regulatory treatment for advances and contributions under the TCJA has been resolved by most of our regulatory jurisdictions in a manner that passes the tax consequences of the change in law to the customer making the advance or contribution, or allows the utility to pass those consequences onto a larger base of customers. We are working with the remaining regulatory jurisdictions to determine impacts to the Company and our customers.

We use our capital resources, including cash, primarily to (i) fund operating and capital requirements, (ii) pay interest and meet debt maturities, (iii) pay dividends, (iv) fund acquisitions, (v) fund pension and postretirement benefit obligations, and (vi) we estimate beginning at the end of 2019, to pay federal income taxes. We invest a significant amount of cash on regulated capital projects where we expect to earn a long-term return on investment. Additionally, we operate in rate regulated environments in which the amount of new investment recovery may be limited, and where such recovery generally takes place over an extended period of time, and certain capital recovery is also subject to regulatory lag. See Item 1—Business—Regulated Businesses—Economic Regulation and Rate Making for additional information. We expect to fund future maturities of long-term debt through a combination of external debt and, to the extent available, cash flows from operations. Since we expect our capital investments over the next few years to be greater than our cash flows from operating activities, we have no plans to reduce debt significantly. If necessary, we may delay certain capital investments or other funding requirements, or pursue financing from other sources to preserve liquidity. In this event, we believe we can rely upon cash flows from operations to meet our obligations and fund our minimum required capital investments for an extended period of time.

With the enactment of the TCJA and the reduction of the U.S. federal corporate income tax rate from 35% to 21%, we anticipate a decrease in future revenue authorizations associated with our Regulated Businesses, initially leading to lower cash flows. We expect this cash flow impact to decline over time, as our Regulated Businesses’ rate base grows, the result of lower deferred income tax liabilities, which offset rate base. The lower deferred income tax liabilities are mainly due to (i) a lower U.S. federal corporate income tax rate, (ii) the normalization (refunding to customers) of the re-measured deferred income tax liabilities over the remaining life of the associated assets, and (iii) the loss of future bonus depreciation deductions on capital projects that began after September 27, 2017.

The Water Infrastructure Finance and Innovation Act of 2014 (“WIFIA”) established the WIFIA program, a federal credit program administered by the EPA for eligible water and wastewater infrastructure projects. The WIFIA program accelerates investment in our nation’s water infrastructure by providing long-term, low-cost supplemental loans for regionally and nationally significant projects. Our letters of interest have been approved by the EPA, and we have begun the full application process for two WIFIA loans totaling $187 million for two separate projects in our Missouri subsidiary.

Cash Flows Provided by Operating Activities

Cash flows provided by operating activities primarily result from the sale of water and wastewater services and, due to the seasonality of demand, are generally greater during the warmer months. Our future cash flows provided by operating activities will be affected by, among other things; economic utility regulation inflation; compliance with environmental, health and safety standards; production costs; maintenance costs; customer growth; declining customer usage of water; employee-related costs, including pension funding; weather and seasonality; taxes; and overall economic conditions.

We expect that the enactment of the TCJA to be accretive to our consolidated earnings over time through (i) growth in rate base for the same level of expected capital expenditures due to the impact of the lower U.S. federal corporate income tax rate and the re-measurement of our deferred income tax assets and liabilities, (ii) increased earnings in our Market-Based Businesses due to the lower U.S. federal corporate income tax rate, all partially offset by (iii) the lower tax shield on interest expense at the parent, as well as increased debt levels from lower cash flows from operations as we pass the lower tax rate benefits to our regulated customers. We believe that we will likely begin paying federal income taxes towards the end of 2019, when we expect our federal NOL carryforwards balance will be fully used, and expect to be a full year cash taxpayer by 2020, although this timing could be impacted by any significant changes in our future results of operations and the outcome of regulatory proceedings regarding the TCJA.

Cash flows provided by operating activities have been a reliable, steady source of funding, sufficient to meet operating requirements and fund the majority of our capital investments. We expect to seek access to debt capital markets to meet the balance of our capital investment, if any, and fund our dividend payments, as needed. We also have access to equity capital markets, if needed. We do not foresee the need to access equity markets over the next five years under normal operating conditions. Operating cash flows can be negatively affected by changes in our rate regulated environments, changes in our Market-Based Businesses, changes in the economy, interest rates, the timing of tax payments, and our customers’ ability to pay for service in a timely manner, among other items. We can provide no assurance that our customers’ historical payment pattern will continue in the future. Sometimes our current liabilities exceed current assets mainly from debt maturities due within one year and the periodic use of short-term debt as a funding source, primarily to meet scheduled maturities of long-term debt, fund acquisitions and construction projects, as well as cash needs which can fluctuate significantly due to the seasonality of the business. We address cash timing differences through the aforementioned liquidity funding mechanisms.

The following table provides a summary of the major items affecting our cash flows provided by operating activities:

	For the Years Ended December 31,
(In millions)	2018				2017				2016
Net income	$	565			$	426			$	468
Add (less):
Depreciation and amortization	545				492				470
Deferred income taxes and amortization of investment tax credits	195				462				295
Non-cash impairment charge	57				—				—
Other non-cash activities (a)	56				16				35
Changes in working capital (b)	30				123				9
Pension and postretirement benefit contributions	(22		)		(48		)		(53		)
Impact of Freedom Industries settlement activities	(40		)		(22		)		65
Net cash flows provided by operating activities	$	1,386			$	1,449			$	1,289

(a)	Includes provision for losses on accounts receivable, (gain) on asset dispositions and purchases, pension and non-pension postretirement benefits and other non-cash, net. Details of each component can be found on the Consolidated Statements of Cash Flows.

(b)	Changes in working capital include changes to receivables and unbilled revenues, accounts payable and accrued liabilities, and other current assets and liabilities, net.

In 2018, cash flows provided by operating activities decreased $63 million, primarily due to lower revenues as a result of the enactment of the TCJA and changes in working capital. These decreases are partially offset by an increase in net income. The main factors contributing to the net income increase are described in this section under “Consolidated Results of Operations” and included higher operating revenue and a lower provision for income taxes.

In 2017, cash flows provided by operations increased $160 million, primarily due to an increase in net income after non-cash adjustments, including the impact of the enactment of the TCJA, and an increase in cash flows from working capital. The main factors contributing to the net income increase are described in the “Consolidated Results of Operations” section and include higher operating revenues, partially offset by higher income taxes due to a $125 million re-measurement charge resulting from the impact of the change in the federal tax rate on the Company’s deferred income taxes from the enactment of the TCJA. The increase in non-cash activities was mainly attributable to the increase in deferred income taxes, as mentioned above, and an increase in depreciation and amortization due to additional utility plant placed in service. The change in working capital was principally due to (i) the timing of accounts payable and accrued liabilities, including the accrual recorded during 2016 for the binding global agreement in principle to settle claims associated with the Freedom Industries chemical spill in West Virginia, (ii) a decrease in unbilled revenues as a result of our Military Services Group achieving significant capital project milestones during 2016, and (iii) a change in other current assets and liabilities, including the decrease in other current assets associated with the termination of our four forward starting swap agreements and timing of payments clearing our cash accounts.

The Company expects to make pension contributions to the plan trusts of up to $31 million in 2019. In addition, we estimate that contributions will amount to $32 million, $29 million, $29 million and $29 million in 2020, 2021, 2022 and 2023, respectively. Actual amounts contributed could change materially from these estimates as a result of changes in assumptions and actual investment returns, among other factors.

Cash Flows Used in Investing Activities

The following table provides a summary of the major items affecting our cash flows used in investing activities:

	For the Years Ended December 31,
(In millions)	2018				2017				2016
Net capital expenditures	$	(1,586	)		$	(1,434	)		$	(1,311	)
Acquisitions	(398		)		(177		)		(204		)
Other investing activities, net (a)	(52		)		(61		)		(75		)
Net cash flows used in investing activities	$	(2,036	)		$	(1,672	)		$	(1,590	)

(a)	Includes removal costs from property, plant and equipment retirements and proceeds from sale of assets.

In 2018 and 2017, cash flows used in investing activities increased primarily due to an increase in our regulated capital expenditures, principally from incremental investments associated with the replacement and renewal of our transmission and distribution infrastructure in our Regulated Businesses, as well as acquisitions in both our Regulated Businesses and Market-Based Businesses, as discussed below.

Our infrastructure investment plan consists of both infrastructure renewal programs, where we replace infrastructure, as needed, and major capital investment projects, where we construct new water and wastewater treatment and delivery facilities to meet new customer growth and water quality regulations. Our projected capital expenditures and other investments are subject to periodic review and revision to reflect changes in economic conditions and other factors.

The following table provides a summary of our historical capital expenditures related to the upgrading of our infrastructure and systems:

	For the Years Ended December 31,
(In millions)	2018				2017				2016
Transmission and distribution	$	572			$	551			$	568
Treatment and pumping	231				171				151
Services, meter and fire hydrants	303				281				297
General structure and equipment	371				281				202
Sources of supply	26				54				59
Wastewater	83				96				34
Total capital expenditures	$	1,586			$	1,434			$	1,311

In 2018, our capital expenditures increased $152 million, or 10.6%, primarily due to investment across the majority of our infrastructure categories. In 2017, our capital expenditures increased $123 million, or 9.4%, primarily due to investment in our general structure and equipment and wastewater categories.

We also grow our business primarily through acquisitions of water and wastewater systems, as well as other water-related services. These acquisitions are complementary to our existing business and support continued geographical diversification and growth of our operations. Generally, acquisitions are funded initially with short-term debt, and later refinanced with the proceeds from long-term debt.

The following is a summary of the acquisitions and dispositions affecting our cash flows from investing activities:

2018:

•	The majority of cash paid for acquisitions pertained to the $365 million purchase of Pivotal within our Homeowner Services Group.

•	Paid $33 million for 15 water and wastewater systems, representing approximately 14,000 customers.

•	Received $35 million for the sale of assets, including $27 million for the sale of the majority of the O&M contracts in our Contract Services Group during the third quarter of 2018.

2017:

•	The majority of cash paid for acquisitions pertained to the $159 million purchase of the wastewater collection and treatment system assets of the Municipal Authority of the City of McKeesport, Pennsylvania (the “McKeesport system”), excluding a $5 million non-escrowed deposit made in 2016.

•	Paid $18 million for 16 water and wastewater systems, excluding the McKeesport system and Shorelands (a stock-for-stock transaction), representing approximately 7,000 customers.

•	Received $15 million for the sale of assets.

2016:

•	Paid $199 million for 15 water and wastewater systems, representing approximately 42,000 customers.

•	Made a non-escrowed deposit of $5 million related to the McKeesport system acquisition.

•	Received $9 million for the sale of assets.

As previously noted, we expect to invest between $8.0 billion to $8.6 billion from 2019 to 2023, with $7.3 billion of this range for infrastructure improvements in our Regulated Businesses. In 2019, we expect to invest between a range of $1.7 billion to $1.8 billion in 2019, with $1.6 billion for infrastructure improvements in our Regulated Businesses. Also in 2019, we expect to invest between $120 million to $240 million for acquisitions in our Regulated Businesses.

Cash Flows from Financing Activities

The following table provides a summary of the major items affecting our cash flows provided by financing activities:

	For the Years Ended December 31,
	2018				2017				2016
(In millions)
Proceeds from long-term debt	$	1,358			$	1,395			$	553
Repayments of long-term debt	(526		)		(896		)		(144		)
Net proceeds from short-term borrowings	60				55				221
Proceeds from issuance of common stock	183				—				—
Dividends paid	(319		)		(289		)		(261		)
Anti-dilutive stock repurchases	(45		)		(54		)		(65		)
Other financing activities, net (a)	15				(4		)		24
Net cash flows provided by financing activities	$	726			$	207			$	328

(a)	Includes proceeds from issuances of common stock under various employee stock plans and our dividend reinvestment plan, net of taxes paid, advances and contributions for construction, net of refunds, and debt issuance costs and make-whole premium on early debt redemption.

In 2018, cash flows provided by financing activities increased $519 million, primarily due to the issuance of common stock to finance a portion of the purchase price of the Pivotal acquisition and a decrease in cash used for short-term borrowings. Short-term borrowings were used to fund the growth of our Regulated Businesses, finance approximately 50% of the Pivotal acquisition, pay dividends and repay long-term debt, offset by the use of the $1.325 billion long-term debt issuance to support growth of the business and repay short-term borrowings.

Our financing activities, primarily focused on funding regulated infrastructure expenditures, regulated and market-based acquisitions and payment of dividends. These activities included the issuance of long-term and short-term debt, primarily through AWCC and in 2018, included an equity issuance for approximately 50% of the Pivotal acquisition. In addition, new infrastructure may be funded with customer advances and contributions in aid of construction, net of refunds, which amounted to $21 million, $28 million and $16 million for the years ended December 31, 2018, 2017 and 2016, respectively. Based on the needs of our Regulated Businesses and the Company, AWCC may borrow funds or issue its debt in the capital markets and then, through intercompany loans, provide those borrowings to the Regulated Businesses and the parent company. The Regulated Businesses and the parent company are obligated to pay their portion of the respective principal and interest to AWCC, in the amount necessary to enable AWCC to meet its debt service obligations. The parent company’s borrowings are not a source of capital for the Regulated Businesses, therefore, the parent company is not able to recover the interest charges on its debt through regulated water and wastewater rates. As of December 31, 2018, AWCC has made long-term fixed rate loans and commercial paper loans to our Regulated Businesses amounting to $4.4 billion and $392 million, respectively. Additionally, as of December 31, 2018, AWCC has made long-term fixed rate loans and commercial paper loans to the parent company amounting $1.7 billion and $533 million, respectively. As of December 31, 2018, the parent company has made long-term fixed rate loans to our Market-Based Businesses amounting to $183 million related to the acquisition of Pivotal on June 4, 2018.

On August 9, 2018, AWCC completed a $1.325 billion debt offering which included the sale of $625 million aggregate principal amount of its unsecured 3.75% Senior Notes due in 2028, and $700 million aggregate principal amount of its unsecured 4.20% Senior Notes due in 2048. At the closing of the offering, AWCC received, after deduction of underwriting discounts and before deduction of offering expenses, net proceeds of approximately $1.3 billion. AWCC used proceeds from the offering to (i) lend funds to American Water and its regulated operating subsidiaries, (ii) repay $191 million principal amount of AWCC’s 5.62% Senior Notes due 2018 upon maturity on December 21, 2018, (iii) prepay $100 million aggregate principal amount of AWCC’s outstanding 5.62% Series E Senior Notes due March 29, 2019 (the “Series E Notes”) and $100 million aggregate principal amount of AWCC’s outstanding 5.77% Series F Senior Notes due March 29, 2022 (the “Series F Notes,” and, together with the Series E Notes, the “Series Notes”), and (iv) repay AWCC’s commercial paper obligations and for general corporate purposes.

As a result of AWCC’s prepayment of the Series Notes, a make-whole premium of $10 million was paid to the holders thereof on September 11, 2018. Substantially all of the early debt extinguishment costs were allocable to our utility subsidiaries and recorded as regulatory assets, as we believe they are probable of recovery in future rates.

On August 6, 2018, the Company terminated four forward starting swap agreements with an aggregate notional amount of $400 million, realizing a net gain of $9 million, to be amortized through interest, net over 10- and 30-year periods, in correlation with the terms of the new debt issued on August 9, 2018.

On August 17, 2018, we entered into two forward starting swap agreements, each with a notional amount of $80 million, to reduce interest rate exposure on debt expected to be issued in 2019. These forward starting swap agreements terminate in August 2019 and have an average fixed rate of 2.98%. On October 11, 2018, we entered into two additional forward starting swap agreements, each with a notional amount of $100 million, to reduce interest rate exposure on debt expected to be issued in 2019. These forward starting swap agreements terminate in December 2019, and have an average fixed rate of 3.31%. On January 8, 2019, we entered into an additional forward starting swap agreement, with a notional amount of $150 million, to reduce interest rate exposure on debt expected to be issued in 2019. This forward starting swap agreement terminates in December 2019, and has an average fixed rate of 2.76%. We have designated these forward starting swap agreements as cash flow hedges, with their fair value recorded in accumulated other comprehensive gain or loss. Upon termination, the cumulative gain or loss recorded in accumulated other comprehensive gain or loss will be amortized through interest, net over the term of the new debt.

One of the principal market risks to which the Company is exposed is changes in interest rates. In order to manage the exposure, we follow risk management policies and procedures, including the use of derivative contracts such as swaps. We reduce exposure to interest rates by managing commercial paper and debt maturities. We do not enter into derivative contracts for speculative purposes and do not use leveraged instruments. The derivative contracts entered into are for periods consistent with the related underlying exposures. The Company is exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. We minimize the counterparty credit risk on these transactions by only dealing with leading, credit-worthy financial institutions, having long-term credit ratings of “A” or better.

On April 11, 2018, we effected an equity forward transaction by entering into a forward sale agreement with each of two forward purchasers in connection with a public offering of 2,320,000 shares of our common stock. In the equity forward transaction, the forward purchasers, or an affiliate, borrowed an aggregate of 2,320,000 shares of our common stock from third parties and sold them to the underwriters in the public offering. On June 7, 2018, we elected to fully and physically settle both forward sale agreements, resulting in the issuance of a total of 2,320,000 shares of our common stock at a price of $79.01 per share, for aggregate net proceeds of $183 million. The net proceeds of the transaction were used to pay a portion of the purchase price of the Pivotal acquisition on June 4, 2018.

In May 2018, the parent company and AWCC filed with the SEC a universal shelf registration statement that enables us to meet our capital needs through the offer and sale to the public from time to time of an unlimited amount of various types of securities, including American Water common stock, preferred stock, and other equity and hybrid securities, and AWCC debt securities, all subject to market conditions and demand, general economic conditions, and as applicable, rating status. The shelf registration statement will expire in May 2021. During 2018, 2017 and 2016, $1.325 billion, $1.350 billion and $550 million, respectively, of debt securities were issued pursuant to this and predecessor registration statements. Additionally, during 2018 under this registration statement, we issued 2,320,000 shares of our common stock at a price of $79.01 per share, for aggregate net proceeds of $183 million.

The following table provides the issuances of long-term debt in 2018:

Company		Type		Rate		Maturity		Amount (in millions)
AWCC (a)		Senior notes—fixed rate		3.75%-4.20%		2028-2048		$	1,325
Other American Water subsidiaries		Private activity bonds and government funded debt—fixed rate (b)		0.00%-5.00%		2021-2048		33
Total issuances								$	1,358

(a)	This indebtedness is considered “debt” for purposes of a support agreement between American Water and AWCC, the Company’s wholly owned finance subsidiary, which serves as a functional equivalent of a guarantee by American Water of AWCC’s payment obligations under such indebtedness.

(b)	Approximately $29 million of this debt relates to the New Jersey Environmental Infrastructure Financing Program.

The following table provides the retirements and redemptions of long-term debt in 2018 through sinking fund provisions, optional redemption or payment at maturity:

Company		Type		Rate		Maturity		Amount (in millions)
AWCC		Senior notes—fixed rate		5.62%-6.25%		2018-2022		$	501
AWCC		Private activity bonds and government funded debt—fixed rate		1.79%-2.90%		2021-2031		1
Other American Water subsidiaries		Private activity bonds and government funded debt—fixed rate		0.00%-5.50%		2018-2047		18
Other American Water subsidiaries		Mortgage bonds—fixed rate		9.13%		2021		1
Other American Water subsidiaries		Mandatorily redeemable preferred stock		8.49%-9.18%		2031-2036		2
Other American Water subsidiaries		Term loan		4.83%-5.69%		2021		3
Total retirements and redemptions								$	526

The following table provides the issuances of long-term debt in 2017:

Company		Type		Rate		Maturity		Amount (in millions)
AWCC		Senior notes—fixed rate		2.95%-3.75%		2027-2047		$	1,350
Other American Water subsidiaries		Private activity bonds and government funded debt—fixed rate		0.00%-1.44%		2020-2037		31
Other American Water subsidiaries		Mortgage bonds—fixed rate		3.92%		2020		3
Other American Water subsidiaries		Term Loan		4.48%-4.98%		2021		11
Total issuances								$	1,395

The following table provides the retirements and redemptions of long-term debt in 2017 through sinking fund provisions, optional redemption or payment at maturity:

Company		Type		Rate		Maturity		Amount (in millions)
AWCC		Senior notes—fixed rate		5.62%-6.09%		2017-2021		$	844
AWCC		Private activity bonds and government funded debt—fixed rate		1.79%-2.90%		2021-2031		1
Other American Water subsidiaries		Private activity bonds and government funded debt—fixed rate		0.00%-5.38%		2017-2041		15
Other American Water subsidiaries		Mortgage bonds—fixed rate		7.08%		2017		33
Other American Water subsidiaries		Mandatorily redeemable preferred stock		8.49%-9.18%		2031-2036		2
Other American Water subsidiaries		Term loan		4.31%-5.31%		2021		1
Total retirements and redemptions								$	896

The following table provides the issuances of long-term debt in 2016:

Company		Type		Rate		Maturity		Amount (in millions)
AWCC		Senior notes—fixed rate		3.00%-4.00%		2026-2046		$	550
Other American Water subsidiaries		Private activity bonds and government funded debt—fixed rate		1.00%-1.36%		2026-2037		3
Total issuances								$	553

The following table provides the retirements and redemptions of long-term debt in 2016 through sinking fund provisions, optional redemption or payment at maturity:

Company		Type		Rate		Maturity		Amount (in millions)
AWCC		Senior notes—fixed rate		5.52%		2016		$	37
AWCC		Private activity bonds and government funded debt—fixed rate		1.79%-2.90%		2021-2031		1
Other American Water subsidiaries		Private activity bonds and government funded debt—fixed rate		0.00%-5.30%		2016-2041		104
Other American Water subsidiaries		Mandatorily redeemable preferred stock		8.49%-9.18%		2031-2036		2
Total retirements and redemptions								$	144

From time to time and as market conditions warrant, we may engage in long-term debt retirements through tender offers, open market repurchases or other viable alternatives to strengthen our balance sheets.

In February 2015, our Board of Directors authorized an anti-dilutive, common stock repurchase program to mitigate the effect of shares issued through our dividend reinvestment, employee stock purchase and executive compensation activities. The program allows the Company to purchase up to 10 million shares of its outstanding common stock, over an unrestricted period of time, in the open market or through privately negotiated transactions. The program is conducted in accordance with Rule 10b-18 of the Exchange Act, and to facilitate the repurchases, we have also entered into Rule 10b5-1 share repurchase plans with a third-party broker, which allows us to repurchase shares at times when we may otherwise be prevented from doing so under insider trading laws or because of self-imposed trading blackout periods. Subject to applicable regulations, we may elect to amend or cancel this repurchase program or the share repurchase parameters at our discretion. As of December 31, 2018, we have repurchased an aggregate of 4,510,000 shares of common stock under this program.

Credit Facilities and Short-Term Debt

We have an unsecured revolving credit facility of $2.25 billion that expires in June 2023. In March 2018, AWCC and its lenders amended and restated the credit agreement with respect to AWCC’s revolving credit facility to increase the maximum commitments under the facility from $1.75 billion to $2.25 billion, and to extend the expiration date of the facility from June 2020 to March 2023. All other terms, conditions and covenants with respect to the existing facility remained unchanged. Subject to satisfying certain conditions, the credit agreement also permits AWCC to increase the maximum commitment under the facility by up to an aggregate of $500 million, and to request extensions of its expiration date for up to two, one-year periods.

Interest rates on advances under the facility are based on a credit spread to the LIBOR rate or base rate in accordance with Moody Investors Service’s and Standard & Poor’s Financial Services’ then applicable credit rating on AWCC’s senior unsecured, non-credit enhanced debt. The facility is used principally to support AWCC’s commercial paper program and to provide up to $150 million in letters of credit. Indebtedness under the facility is considered “debt” for purposes of a support agreement between the Company and AWCC, which serves as a functional equivalent of a guarantee by the Company of AWCC’s payment obligations under the credit facility.

AWCC also has an outstanding commercial paper program that is backed by the revolving credit facility, the maximum aggregate outstanding amount of which was increased in March 2018, from $1.60 billion to $2.10 billion.

The following table provides the aggregate credit facility commitments, letter of credit sub-limit under the revolving credit facility and commercial paper limit, as well as the available capacity for each as of December 31, 2018 and 2017:

(In millions)	Credit Facility Commitment				Available Credit Facility Capacity				Letter of Credit Sublimit				Available Letter of Credit Capacity				Commercial Paper Limit				Available Commercial Paper Capacity
December 31, 2018	$	2,262			$	2,177			$	150			$	69			$	2,100			$	1,146
December 31, 2017	1,762				1,673				150				66				1,600				695

The weighted average interest rate on AWCC short-term borrowings for the years ended December 31, 2018 and 2017 was approximately 2.28% and 1.24%, respectively.

Capital Structure

The following table provides the percentage of our capitalization represented by the components of our capital structure as of December 31:

	2018			2017			2016
Total common shareholders' equity	40.4	%		41.0	%		42.1	%
Long-term debt and redeemable preferred stock at redemption value	52.4	%		49.6	%		46.4	%
Short-term debt and current portion of long-term debt	7.2	%		9.4	%		11.5	%
Total	100	%		100	%		100	%

The changes in the capital structure between periods were mainly attributable to an increase in long-term debt.

Debt Covenants

Our debt agreements contain financial and non-financial covenants. To the extent that we are not in compliance with these covenants, an event of default may occur under one or more debt agreements and we or our subsidiaries may be restricted in our ability to pay dividends, issue new debt or access our revolving credit facility. Our long-term debt indentures contain a number of covenants that, among other things, prohibit or restrict the Company from issuing debt secured by the Company’s assets, subject to certain exceptions. Our failure to comply with any of these covenants could accelerate repayment obligations.

Covenants in certain long-term notes and the revolving credit facility require us to maintain a ratio of consolidated debt to consolidated capitalization (as defined in the relevant documents) of not more than 0.70 to 1.00. On December 31, 2018, our ratio was 0.59 to 1.00 and therefore we were in compliance with the covenants.

Security Ratings

Our access to the capital markets, including the commercial paper market, and respective financing costs in those markets, may be directly affected by our securities ratings. We primarily access the debt capital markets, including the commercial paper market, through AWCC. However, we have also issued debt through our regulated subsidiaries, primarily in the form of tax exempt securities or borrowings under state revolving funds, to lower our overall cost of debt.

The following table provides our long-term and short-term credit rating and rating outlook as of February 19, 2019:

Securities		Moody’s Investors Service		Standard & Poor’s Ratings Service
Rating Outlook		Negative		Stable
Senior unsecured debt		A3		A
Commercial paper		P-2		A-1

On June 11, 2018, Standard & Poor’s Ratings Service affirmed the Company’s long-term ‘A’ and short-term ‘A-1’ credit ratings, with a stable outlook remaining unchanged.

On January 19, 2018, Moody’s Investors Service changed its rating outlook to negative, from stable, for 24 regulated utilities and utility holding companies, including the Company, all of which were primarily impacted by the enactment of the TCJA.

A security rating is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating agency, and each rating should be evaluated independently of any other rating. Security ratings are highly dependent upon our ability to generate cash flows in an amount sufficient to service our debt and meet our investment plans. We can provide no assurances that our ability to generate cash flows is sufficient to maintain our existing ratings. None of our borrowings are subject to default or prepayment as a result of the downgrading of these security ratings, although such a downgrading could increase fees and interest charges under our credit facility.

As part of the normal course of business, we routinely enter into contracts for the purchase and sale of water, energy, chemicals and other services. These contracts either contain express provisions or otherwise permit us and our counterparties to demand adequate assurance of future performance when there are reasonable grounds for doing so. In accordance with the contracts and applicable contract law, if we are downgraded by a credit rating agency, especially if such downgrade is to a level below investment grade, it is possible that a counterparty would attempt to rely on such a downgrade as a basis for making a demand for adequate assurance of future performance, which could include a demand that we provide collateral to secure our obligations. We do not expect to post any collateral which will have a material adverse impact on the Company’s results of operations, financial position or cash flows.

Dividends and Regulatory Restrictions

For discussion of our dividends, dividend restrictions and dividend policy, see Note 9—Shareholders' Equity in the Notes to Consolidated Financial Statements for additional information.

Insurance Coverage

We carry various property, casualty and financial insurance policies with limits, deductibles and exclusions that we believe are consistent with industry standards. However, insurance coverage may not be adequate or available to cover unanticipated losses or claims. Additionally, annual policy renewals can be impacted by claims experience which in turn can impact coverage terms and conditions on a going-forward basis. We are self-insured to the extent that losses are within the policy deductible or exceed the amount of insurance maintained. Such losses could have a material adverse effect on our short-term and long-term financial condition and our results of operations and cash flows.

Contractual Obligations and Commitments

We enter into contractual obligations with third parties in the ordinary course of business. The following table provides information related to our contractual obligations as of December 31, 2018:

(In millions)	Total				1 year or less				2-3 years				4-5 years				More than 5 years
Long-term debt obligations (a)	$	7,655			$	72			$	335			$	184			$	7,064
Interest on long-term debt (b)	5,832				352				688				648				4,144
Operating lease obligations (c)	141				17				27				17				80
Purchase water obligations (d)	957				65				130				121				641
Other purchase obligations (e)	637				637				—				—				—
Pension plan obligations (f)	156				31				64				61				—
Other obligations (g)	924				312				255				62				295
Total	$	16,302			$	1,486			$	1,499			$	1,093			$	12,224

NOTE

The above table reflects only financial obligations and commitments. Therefore, performance obligations associated with our Market-Based Businesses are not included in the above amounts. Also, uncertain tax positions of $97 million are not reflected in this table as we cannot predict when open tax years will close with completed examinations. See Note 14—Income Taxes in the Notes to Consolidated Financial Statements.

(a)	Represents sinking fund obligations, debt maturities, capital lease obligations and preferred stocks with mandatory redemption requirements.

(b)	Represents expected interest payments on outstanding long-term debt and interest on preferred stock with mandatory redemption requirements. Amounts reported may differ from actual due to future financing of debt.

(c)	Represents future minimum payments under non-cancelable operating leases, primarily for the lease of motor vehicles, buildings, land and other equipment including water facilities and systems constructed by partners under the Public-Private Partnerships described below.

(d)	Represents future payments under water purchase agreements for minimum quantities of water.

(e)	Represents the open purchase orders as of December 31, 2018 for goods and services purchased in the ordinary course of business.

(f)	Represents contributions expected to be made to pension for the years 2019 through 2023.

(g)	Includes an estimate of advances for construction to be refunded, capital expenditures estimated to be required under legal and binding contractual obligations, contracts entered into for energy purchases, a liability associated with a conservation agreement, and service agreements.

Public-Private Partnerships

WVAWC has entered into a series of agreements with various public entities, which we refer to as the Partners, to establish certain joint ventures, commonly referred to as “public-private partnerships.” Under the public-private partnerships, WVAWC constructed utility plant, financed by WVAWC, and the Partners constructed utility plant (connected to WVAWC’s property), financed by the Partners. WVAWC agreed to transfer and convey some of its real and personal property to the Partners in exchange for an equal principal amount of Industrial Development Bonds, commonly referred to as IDBs, issued by the Partners under a state Industrial Development Bond and Commercial Development Act. WVAWC leased back the total facilities, including portions funded by both WVAWC and the Partners, under leases for a period of 40 years.

The leases have payments that approximate the payments required by the terms of the IDBs. These payments are considered “PILOT payments” which represent payments that WVAWC otherwise would pay as property taxes on the properties. We have presented the transaction on a net basis on the Consolidated Financial Statements. The carrying value of the transferred facilities, which is presented in property, plant and equipment on the Consolidated Balance Sheets, was approximately $147 million as of December 31, 2018.

Performance Obligations

We have entered into agreements for the provision of services to water and wastewater facilities for the United States military, municipalities and other customers. For discussion of our performance obligations see Note 3—Revenue Recognition in the Notes to Consolidated Financial Statements for additional information.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with GAAP requires that management apply accounting policies and make estimates, assumptions and judgments that could affect the Company’s financial condition, results of operations and cash flows. Actual results could differ from these estimates, assumptions and judgments. Management believes that the areas described below require significant judgment in the application of accounting policy or in making estimates and assumptions in matters that are inherently uncertain and that may change in subsequent periods. Accordingly, changes in the estimates, assumptions and judgments applied to these accounting policies could have a significant impact on our financial condition, results of operations and cash flows, as reflected in our Consolidated Financial Statements. Management has reviewed the critical accounting polices described below with our Audit, Finance and Risk Committee, including the estimates, assumptions and judgments used in their application. Additional discussion regarding these critical accounting policies and their application can be found in Note 2—Significant Accounting Policies in the Notes to Consolidated Financial Statements.

Regulation and Regulatory Accounting

Our regulated utilities are generally subject to economic regulation by PUCs and, as such, we follow the authoritative accounting principles required for rate regulated utilities, which requires us to reflect the effects of rate regulation in our Consolidated Financial Statements. Use of this authoritative guidance is applicable to utility operations that meet the following criteria: (i) third-party regulation of rates; (ii) cost-based rates; and (iii) a reasonable assumption that rates will be set to recover the estimated costs of providing service, plus a return on net investment, or rate base. As of December 31, 2018, we concluded that the operations of our utilities met the criteria.

Application of this authoritative guidance has a further effect on our financial statements as it pertains to allowable costs used in the ratemaking process. We make significant assumptions and estimates to quantify amounts recorded as regulatory assets and liabilities. Such judgments include, but are not limited to, assets and liabilities related to regulated acquisitions, pension and postretirement benefits, depreciation rates and taxes. Due to timing and other differences in the collection of revenues, these authoritative accounting principles allow a cost that would otherwise be charged as an expense by a non-regulated entity, to be deferred as a regulatory asset if it is probable that such cost is recoverable through future rates. Conversely, the principles require the creation of a regulatory liability for amounts collected in rates to recover costs expected to be incurred in the future, or amounts collected in excess of costs incurred and are refundable to customers. Regulators may also impose certain fines or penalties.

For each regulatory jurisdiction where we conduct business, we assess, at the end of each reporting period, whether the regulatory assets and liabilities continue to meet the criteria for probable, future recovery or settlement. This assessment includes consideration of factors such as changes in applicable regulatory environments; recent rate orders on recovery of a specific or similar incurred cost to other regulated entities in the same jurisdiction and the status of any pending or potential legislation that could impact the ability to recover costs through regulated rates. If subsequent events indicate that the regulatory assets or liabilities no longer meet the criteria for probable, future recovery or settlement, our Consolidated Statements of Operations and financial position could be materially affected. In addition, if we conclude in a future period that a separable portion of the business no longer meets the criteria, we are required to eliminate the financial statement effects of regulation for that part of the business, which would include the elimination of any or all regulatory assets and liabilities that had been recorded in the Consolidated Financial Statements. Failure to meet the criteria of this authoritative guidance could materially impact our Consolidated Financial Statements.

On December 22, 2017, the TCJA was signed into law, which, among other things, enacted significant and complex changes to the Internal Revenue Code of 1986, including a reduction in the maximum U.S. federal corporate income tax rate from 35% to 21% as of January 1, 2018. The TCJA created significant excess deferred income taxes that we and our regulatory jurisdictions believe should be refunded to customers. As such, we recorded these amounts as regulatory liabilities.

As of December 31, 2018 and 2017, our regulatory asset balance was $1.2 billion and $1.1 billion, respectively, and our regulatory liability balance was $1.9 billion and $1.7 billion, respectively. See Note 7—Regulatory Assets and Liabilities in the Notes to Consolidated Financial Statements for further information regarding our significant regulatory assets and liabilities.

Goodwill

As of December 31, 2018 and 2017, our goodwill balances were $1.6 billion and $1.4 billion, respectively. In accordance with GAAP, goodwill must be allocated at the reporting unit level, which is defined as an operating segment or one level below, and tested for impairment at least annually. We perform our annual impairment testing of goodwill as of November 30 of each year, or more frequently if an event occurs or circumstances change that would more likely than not, reduce the fair value of a reporting unit below its carrying value. Adverse industry or economic trends, lower projections of profitability, or a sustained decline in our market capitalization, among other things, may be indicators of potential goodwill impairment issues, requiring further testing of a reporting unit’s carrying value.

Entities testing goodwill for impairment have the option of first performing a qualitative assessment to determine whether quantitative testing is necessary. In performing a qualitative assessment, we assess and make judgments, among other things, around macroeconomic conditions, industry and market conditions, overall financial performance, cost factors and entity specific events. These factors require significant judgment and estimates, and application of alternative assumptions could produce significantly different results. If it is determined, based upon qualitative factors, that the estimated fair value of a reporting unit is more likely than not, greater than its carrying value, no further testing is required. If we bypass the qualitative assessment, or perform the qualitative assessment and determine that the estimated fair value of a reporting unit is more likely than not less than its carrying value, a quantitative, fair value-based test is performed. This quantitative test compares the estimated fair value of the reporting unit to its respective net carrying value, including goodwill, on the measurement date. An impairment loss will be recognized in the amount equal to the excess of the reporting unit’s carrying value compared to its estimated fair value, limited to the total amount of goodwill allocated to that reporting unit.

Application of goodwill impairment testing requires management judgment, including the identification of reporting units and determining the fair value of reporting units. We estimate fair value using a combination of a discounted cash flow analysis and a market multiples analysis. Significant assumptions used in these fair value analyses include, but are not limited to, forecasts of future operating results, discount and growth rates, capital expenditures, tax rates, working capital, weighted average cost of capital and projected terminal values. Changes in estimates or the application of alternative assumptions could produce significantly different results. See Note 8—Goodwill and Other Intangible Assets in the Notes to Consolidated Financial Statements for additional information regarding our goodwill.

Impairment of Long-Lived Assets

Long-lived assets include property, plant and equipment, goodwill, intangible assets and long-term investments. We evaluate our long-lived assets for impairment when circumstances indicate the carrying value of those assets may not be recoverable. Such circumstances include, but are not limited to, a significant decrease in the market value of the asset, a change in the asset’s expected useful life or physical condition, a history of operating or cash flow losses associated with the use of the asset or a significant adverse change in the manner in which the asset is being used or is planned to be used. When such indicators arise, we estimate the fair value of the long-lived asset from future cash flows expected to result from its use and, if applicable, the eventual disposition of the asset, and compare the estimated value fair to the carrying value of the asset. An impairment loss will be recognized in the amount equal to the excess of the long-lived asset’s carrying value compared to its estimated fair value. Key variables that must be estimated include assumptions regarding sales volume, rates, operating costs, labor and other benefit costs, capital additions, assumed discount rates and other economic factors. These variables require management judgment and include inherent uncertainties, since they are forecasting future events. A variation in the assumptions used could lead to a different conclusion regarding the realizability of a long-lived asset and, thus, could have a significant effect on our Consolidated Financial Statements.

The long-lived assets of our Regulated Businesses are grouped on a separate entity basis for impairment testing, as they are integrated state-wide operations that do not have the option to curtail service and generally have uniform tariffs. A regulatory asset is charged to earnings if and when future recovery in rates of that asset is no longer probable.

The Company holds other investments in privately held companies and joint ventures accounted for using the equity method. The estimated fair value of the long-term investments are dependent on the financial performance and solvency of the entities in which the Company invests, as well as volatility inherent in the external markets. If such long-term investments are considered impaired, an impairment loss will be recognized in the amount equal to the excess of the investment’s carrying value compared to its estimated fair value.

The Company believes the assumptions and other considerations used to value long-lived assets to be appropriate, however, if actual experience differs from the assumptions and considerations used in its estimates, the resulting change could have a material adverse impact on the Consolidated Financial Statements.

Revenue Recognition

Revenue from the Company’s Regulated Businesses is generated primarily from water and wastewater services delivered to customers. These contracts contain a single performance obligation, the delivery of water or wastewater services, as the promise to transfer the individual good or service is not separately identifiable from other promises within the contracts and, therefore, is not distinct. Revenues are recognized over time, as services are provided. There are generally no significant financing components or variable consideration. Revenues include amounts billed to customers on a cycle basis, and unbilled amounts calculated based on estimated usage from the date of the meter reading associated with the latest customer bill, to the end of the accounting period. The amounts that the Company has a right to invoice are determined by each customer’s actual usage, an indicator that the invoice amount corresponds directly to the value transferred to the customer.

Increases or decreases in the volumes delivered to customers and rate mix due to changes in usage patterns in customer classes in the period could be significant to the calculation of unbilled revenue. In addition, changes in the timing of meter reading schedules and the number and type of customers scheduled for each meter reading date would also have an effect on the unbilled revenue calculation. Unbilled revenue for our regulated utilities as of December 31, 2018 and 2017 was $144 million and $152 million, respectively.

The Company also recognizes revenue when it is probable that future recovery of previously incurred costs or future refunds that are to be credited to customers will occur through the ratemaking process.

Revenue from the Company’s Homeowner Services Group is generated through various protection programs in which the Company provides fixed fee services to domestic homeowners and smaller commercial customers to protect against repair costs for interior and external water and sewer lines, interior electric and gas lines, heating and cooling systems, water heaters, power surge protection and other related services. Most of the contracts have a one-year term and each service is a separate performance obligation, satisfied over time, as the customers simultaneously receive and consume the benefits provided from the service. Customers are obligated to pay for the protection programs ratably over 12 months or via a one-time, annual fee, with revenues recognized ratably over time for these services. Advances from customers are deferred until the performance obligation is satisfied.

The Company also has long-term, fixed fee contracts to operate and maintain water and wastewater facilities with the U.S. government on various military bases and facilities owned by municipal and industrial customers, as well as shorter-term contracts that provide customized water transfer services for shale natural gas companies and customers. Billing and revenue recognition for the fixed fee revenues occurs ratably over the term of the contract, as customers simultaneously receive and consume the benefits provided by the Company. Additionally, these contracts allow the Company to make capital improvements to underlying infrastructure, which are initiated through separate modifications or amendments to the original contract, whereby stand-alone, fixed pricing is separately stated for each improvement. The Company has determined that these capital improvements are separate performance obligations, with revenue recognized over time based on performance completed at the end of each reporting period. Losses on contracts are recognized during the period in which the losses first become probable and estimable. Revenues recognized during the period in excess of billings on construction contracts are recorded as unbilled revenues, with billings in excess of revenues recorded as other current liabilities until the recognition criteria are met. Changes in contract performance and related estimated contract profitability may result in revisions to costs and revenues, and are recognized in the period in which revisions are determined. Unbilled revenue for our Market-Based Businesses as of December 31, 2018 and 2017 was $42 million and $60 million, respectively.

Accounting for Income Taxes

Significant management judgment is required in determining the provision for income taxes, primarily due to the uncertainty related to tax positions taken, as well as deferred tax assets and liabilities, valuation allowances and the utilization of NOL carryforwards.

In accordance with applicable authoritative guidance, we account for uncertain income tax positions using a benefit recognition model with a two-step approach, including a more-likely-than-not recognition threshold and a measurement approach based on the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement. If it is not more-likely-than-not that the benefit of the tax position will be sustained on its technical merits, no benefit is recorded. Uncertain tax positions that relate only to timing of when an item is included on a tax return are considered to have met the recognition threshold. Management evaluates each position based solely on the technical merits and facts and circumstances of the position, assuming the position will be examined by a taxing authority having full knowledge of all relevant information. Significant judgment is required to determine whether the recognition threshold has been met and, if so, the appropriate amount of unrecognized tax benefit to be recorded in the Consolidated Financial Statements.

We evaluate the probability of realizing deferred tax assets quarterly by reviewing a forecast of future taxable income and our intent and ability to implement tax planning strategies, if necessary, to realize deferred tax assets. We also assess our ability to utilize tax attributes, including those in the form of carryforwards, for which the benefits have already been reflected in the financial statements. We record valuation allowances for deferred tax assets when we conclude it is more-likely-than-not such benefit will not be realized in future periods.

Under GAAP, specifically Accounting Standards Codification Topic 740, Income Taxes (“ASC 740”), the tax effects of changes in tax laws must be recognized in the period in which the law is enacted. ASC 740 also requires deferred tax assets and liabilities to be measured at the enacted tax rate expected to apply when temporary differences are to be realized or settled. Thus, at the date of enactment of the TCJA, the Company’s deferred taxes were re-measured based upon the new tax rate. For our regulated entities, the change in deferred taxes are recorded as either an offset to a regulatory asset or liability and may be subject to refund to customers. For our unregulated operations, the change in deferred taxes are recorded as a non-cash re-measurement adjustment to earnings.

The staff of the SEC has recognized the complexity of reflecting the impacts of changes in tax law, more specifically the TCJA, and on December 22, 2017, issued guidance in SAB 118 which clarifies accounting for income taxes under ASC 740 if information is not yet available or complete and provides for up to a one year period in which to complete the required analyses and accounting. SAB 118 describes three scenarios or buckets associated with a company’s status of accounting for the TCJA: (i) a company is complete with its accounting for certain effects of tax reform; (ii) a company is able to determine a reasonable estimate for certain effects of tax reform and records that estimate as a provisional amount; or (iii) a company is not able to determine a reasonable estimate and therefore continues to apply ASC 740, based on the provisions of the tax laws that were in effect immediately prior to the TCJA being enacted. The significant assumptions considered and evaluated by the Company relating to accounting for the TCJA, include, but are not limited to, the:

•	recording of regulatory liabilities from the re-measurement of the Company’s deferred income taxes, and the uncertainty of regulatory treatment in various jurisdictions in which the Company currently operates;

•	allocation to our subsidiaries of interest deductibility at the parent;

•	bonus depreciation deductions for assets constructed and placed in service during the period from September 28, 2017 through December 31, 2017; and

•	normalization periods for our re-measured deferred taxes.

Actual income taxes could vary from estimated amounts due to the future impacts of various items, including changes in income tax laws, our forecasted financial condition and results of operations, failure to successfully implement tax planning strategies and recovery of taxes through the regulatory process for our Regulated Businesses, as well as results of audits and examinations of filed tax returns by taxing authorities. While we believe the resulting tax balances as of December 31, 2018 and 2017 are appropriately accounted for in accordance with the applicable authoritative guidance, the ultimate outcome of tax matters could result in favorable or unfavorable adjustments to our Consolidated Financial Statements and such adjustments could be material. See Note 14—Income Taxes in the Notes to Consolidated Financial Statements for additional information regarding income taxes.

Accounting for Pension and Postretirement Benefits

We maintain noncontributory defined benefit pension plans covering eligible employees of our regulated utility and shared service operations. See Note 15—Employee Benefits in the Notes to Consolidated Financial Statements for additional information regarding the description of and accounting for the defined benefit pension plans and postretirement benefit plans.

The Company’s pension and postretirement benefit costs are developed from actuarial valuations. Inherent in these valuations are key assumptions provided by the Company to its actuaries, including the discount rate and expected long-term rate of return on plan assets. Material changes in the Company’s pension and postretirement benefit costs may occur in the future due to changes in these assumptions as well as fluctuations in plan assets. The assumptions are selected to represent the average expected experience over time and may differ in any one year from actual experience due to changes in capital markets and the overall economy. These differences will impact the amount of pension and other postretirement benefit expense that the Company recognizes. The primary assumptions are:

•

Discount Rate—The discount rate is used in calculating the present value of benefits, which are based on projections of benefit payments to be made in the future. The objective in selecting the discount rate is to measure the single amount that, if invested at the measurement date in a portfolio of high-quality debt instruments, would provide the necessary future cash flows to pay the accumulated benefits when due.

•	Expected Return on Plan Assets (“EROA”)—Management projects the future return on plan assets considering prior performance, but primarily based upon the plans’ mix of assets and expectations for the long-term returns on those asset classes. These projected returns reduce the net benefit costs we record currently.

•	Rate of Compensation Increase—Management projects employees’ pay increases, which are used to project employees’ pension benefits at retirement.

•	Health Care Cost Trend Rate—Management projects the expected increases in the cost of health care.

•	Mortality—Management retained the Society of Actuaries RP-2014 mortality base table, which provides rates of mortality in 2006, but adopted the new MP-2018 mortality improvement scale to gradually adjust future mortality rates downward due to increased longevity in each year after 2006.

The discount rate assumption, which is determined for the pension and postretirement benefit plans independently, is subject to change each year, consistent with changes in applicable high-quality, long-term corporate bond indices. We use an approach that approximates the process of settlement of obligations tailored to the plans’ expected cash flows by matching the plans’ cash flows to the coupons and expected maturity values of individually selected bonds. For each plan, the discount rate was developed as the level equivalent rate that would yield the same present value as using spot rates aligned with the projected benefit payments. The discount rate for determining pension benefit obligations was 4.38%, 3.75% and 4.28% at December 31, 2018, 2017 and 2016, respectively. The discount rate for determining other postretirement benefit obligations was 4.32%, 3.73% and 4.26% at December 31, 2018, 2017 and 2016, respectively.

In selecting an EROA, we considered tax implications, past performance and economic forecasts for the types of investments held by the plans. The long-term EROA assumption used in calculating pension cost was 5.95% for 2018, 6.49% for 2017, and 7.02% for 2016. The weighted average EROA assumption used in calculating other postretirement benefit costs was 4.77% for 2018, 5.09% for 2017 and 5.37% for 2016.

The following table provides the allocations of the pension plan assets by asset category:

		2019 Target Allocation			Percentage of Plan Assets as of December 31,
Asset Category			2018			2017
Equity securities		43	%		42	%		44	%
Fixed income		50	%		52	%		49	%
Real Estate		5	%		5	%		5	%
Real estate investment trusts (“REITs”)		2	%		1	%		2	%
Total		100	%		100	%		100	%

During 2017, the Company reduced the risk of its investments in the pension plan by reducing its exposure to equities from 60% to 50%, and increasing its long duration fixed-income allocation from 40% to 50%. This structure is designed to reduce the plan’s funded status volatility. It is also intended to reduce the pension plan’s exposure to interest rates since a higher proportion of long duration fixed-income securities that have a duration similar to that of the pension liabilities should reduce interest rate risk associated with the plan’s liabilities.

Postretirement Medical Bargaining Plan Changes

On July 31, 2018, a new, five-year national benefits agreement was ratified, covering approximately 3,200 of our union-represented employees. Most of the benefits under this new agreement will become effective on January 1, 2019, and include, among other things, union-represented employees’ participation in the Company’s cash-based annual performance plan, additional medical plan options and changes to certain retiree medical benefits, which required the Company to remeasure its other postretirement benefit plan obligation during the third quarter of 2018.

For those eligible union retirees and dependents over age 65, the current supplemental retiree medical plan will be replaced with a Health Reimbursement Arrangement (“HRA”) similar to the cap currently in place for non-union retirees. The Company is providing a subsidy allowing the post-65 retirees to purchase a Medicare supplemental plan on a private exchange network. The pre-65 coverage plan was also amended to provide a cap on future employer costs designed to limit the employer costs to 2018 levels. For pre-65 union members retiring early in 2019-2021 a supplemental benefit will be provided to alleviate the effect of the cap.

On August 31, 2018, the Postretirement Medical Benefit Plan was remeasured to reflect this plan change. The plan change resulted in a $175 million reduction in future benefits payable to plan participants, and, in combination with other experience reflected as of the remeasurement date, resulted in a $227 million reduction to the net accumulated postretirement benefit obligation. The plan amendment will be amortized over 10.2 years, the average future working lifetime to full eligibility age for all plan participants.

After the remeasurement, the Retirement and Benefit Plans Investment Committee (the “Investment Committee”), which is responsible for overseeing the investment of the Company’s pension and other postretirement benefit plans’ assets, determined that the funded status of the Postretirement Medical Bargaining Plan was in excess of that needed to pay current and future benefits.

Given the change in funded status, the Investment Committee commissioned a new asset-liability study for the Postretirement Medical Bargaining Plan. This study concluded that it was prudent to decrease the risk in the plan and to remove its equity exposure. The study also recommended reducing its exposure to changes in interest rates by matching the assets of the plan to the projected cash flows for future benefit payments of the liability. The Investment Committee agreed with the recommendations and approved the investment of the Postretirement Medical Bargaining Plan assets in fixed-income securities.

The restructuring of the plan was initiated toward year-end. Once fully completed, the plan’s assets will be invested in fixed-income securities. The majority of the securities will be used to match the projected cash flows for future benefit payments of the liability. Plan assets in excess of those securities designed to match the long-term liabilities will be invested in shorter duration securities with a duration of about three years.

The following table provides the allocations of the other postretirement benefit plan assets by asset category:

		2019 Target Allocation (a)			Percentage of Plan Assets as of December 31,
Asset Category			2018			2017
Equity securities		14	%		17	%		35	%
Fixed income		86	%		83	%		65	%
REITs		—			—			—
Total		100	%		100	%		100	%

(a)	Includes the American Water Postretirement Medical Benefits Bargaining Plan, the New York Water Service Corporation Postretirement Medical Benefits Bargaining Plan, the American Water Postretirement Medical Benefits Non-Bargaining Plan, and the American Water Life Insurance Trust.

The investments of the pension and postretirement welfare plan trusts include debt and equity securities held either directly or through commingled funds. The trustee for the Company’s defined benefit pension and postretirement welfare plans uses an independent valuation firm to calculate the fair value of plan assets. Additionally, the Company independently verifies the assets’ values. Approximately 88% of the assets are valued using the quoted market price for the assets in an active market at the measurement date, while 12% of the assets are valued using other inputs.

In selecting a rate of compensation increase, we consider past experience in light of movements in inflation rates. Our rate of compensation increase was 3% for 2018, 3.02% for 2017 and 3.07% for 2016.

In selecting health care cost trend rates, we consider past performance and forecasts of increases in health care costs. As of January 1, 2017, our health care cost trend rate assumption used to calculate the periodic cost was 7% in 2018 gradually declining to 4.5% in 2026 and thereafter. As of December 31, 2018, the Company is projecting that medical inflation will be 6.75% in 2019 and, it will ultimately trend down to 5%, but not until 2026.

We will use a discount rate and EROA of 4.38% and 6.2%, respectively, for estimating our 2019 pension costs. Additionally, we will use a discount rate and expected blended return based on weighted assets of 4.32% and 3.56%, respectively, for estimating our 2019 other postretirement benefit costs. A decrease in the discount rate or the EROA would increase our pension expense. Our 2018 and 2017 pension and postretirement benefit costs were $21 million and $56 million, respectively. The Company expects to make pension and postretirement benefit contributions to the plan trusts up to $31 million in 2019, and $32 million, $29 million, $29 million and $29 million in 2020, 2021, 2022 and 2023, respectively. Actual amounts contributed could change significantly from these estimates. The assumptions are reviewed annually and at any interim re-measurement of the plan obligations. The impact of assumption changes is reflected in the recorded pension and postretirement benefit amounts as they occur, or over a period of time if allowed under applicable accounting standards. As these assumptions change from period to period, recorded pension and postretirement benefit amounts and funding requirements could also change.

Accounting for Contingencies

We record loss contingencies when management determines that the outcome of future events is probable of occurring and when the amount of the loss or a range of losses can be reasonably estimated. The determination of a loss contingency is based on management’s judgment and estimates about the likely outcome of the matter, which may include an analysis of different scenarios. Liabilities are recorded or adjusted when events or circumstances cause these judgments or estimates to change. In assessing whether a loss is reasonably possible, management considers many factors, which include, but are not limed to: the nature of the litigation, claim or assessment, review of applicable law, opinions or views of legal counsel and other advisors, and the experience gained from similar cases or situations. We provide disclosures for material contingencies when management deems there is a reasonable possibility that a loss or an additional loss may be incurred. We provide estimates of reasonably possible losses when such estimates may be reasonably determined, either as a single amount or within a reasonable range.

Actual amounts realized upon settlement of contingencies may be different than amounts recorded and disclosed and could have a significant impact on the liabilities, revenue and expenses recorded on the Consolidated Financial Statements. See Note 16—Commitments and Contingencies in the Notes to Consolidated Financial Statements for additional information regarding contingencies.

New Accounting Standards

See Note 2—Significant Accounting Policies in the Notes to Consolidated Financial Statements for a description of recent accounting standards.