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AQUA AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)
The reclassification of goodwill to utility plant acquisition adjustment results from a mechanism approved by the applicable utility commission. The mechanism provides for the transfer over time, and the recovery through customer rates, of goodwill associated with some acquisitions upon achieving specific objectives.
Note 3 – Acquisitions
Pursuant to our strategy to grow through acquisitions, in January 2016, the Company acquired Superior Water Company, Inc., which provides public water service to approximately 3,900 customers in portions of Berks, Chester, and Montgomery counties in Pennsylvania. The total purchase price for the utility system was $16,750, which consisted of the issuance of 439,943 shares of the Company’s common stock and $3,905 in cash. The purchase price allocation for this acquisition consists primarily of acquired property, plant and equipment of $25,167, contributions in aid of construction of $16,565, and goodwill of $8,622. Additionally, during the first quarter of 2016, the Company completed six acquisitions of water and wastewater utility systems in various states. The total purchase price of these utility systems consisted of $556 in cash. The pro forma effect of the business acquired is not material either individually or collectively to the Company’s results of operations.
In April 2015, the Company acquired the water and wastewater utility system assets of North Maine Utilities located in the Village of Glenview, Illinois serving approximately 7,400 customers. The total purchase price consisted of $23,079 in cash. The purchase price allocation for this acquisition consists primarily of acquired property, plant and equipment. Additionally, in 2015, the Company completed 14 acquisitions of water and wastewater utility systems in various states. The total purchase price of these utility systems consisted of $5,210 in cash.
Note 4 – Assets Held for Sale
In December 2015, the Company decided to sell a business unit within the Company’s market-based subsidiary, Aqua Resources, which provides liquid waste hauling and disposal services, and is reported as assets held for sale in the Company’s Consolidated Balance Sheets. The completion of the sale is expected to occur in the second quarter of 2016. This business unit is included in “Other” in the Company’s segment information.
]
Note 5 – Capitalization
In February 2016, the Company amended its unsecured revolving credit facility to extend the expiration from March 2017 to February 2021, to increase the facility from $200,000 to $250,000, and to add a fourth bank to the lending group. Funds borrowed under this facility are classified as long-term debt and are used to provide working capital as well as support for letters of credit for insurance policies and other financing arrangements. Interest under this facility is based at the Company’s option, on the prime rate, an adjusted Euro-Rate, an adjusted federal funds rate or at rates offered by the banks. A facility fee is charged on the total commitment amount of the agreement.
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AQUA AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)
Note 6 – Fair Value of Financial Instruments
The Company follows the Financial Accounting Standards Board’s (“FASB”) accounting guidance for fair value measurements and disclosures, which defines fair value and establishes a framework for using fair value to measure assets and liabilities. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:
| · | | Level 1: unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access; |
| · | | Level 2: inputs other than Level 1 that are observable, either directly or indirectly, such as quoted market prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in non-active markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; or |
| · | | Level 3: inputs that are unobservable and significant to the fair value measurement. |
The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. There have been no changes in the valuation techniques used to measure fair value or asset or liability transfers between the levels of the fair value hierarchy for the quarter ended March 31, 2016.
Financial instruments are recorded at carrying value in the financial statements and approximate fair value as of the dates presented. The fair value of these instruments is disclosed below in accordance with current accounting guidance related to financial instruments.
The fair value of loans payable is determined based on its carrying amount and utilizing Level 1 methods and assumptions. As of March 31, 2016 and December 31, 2015, the carrying amount of the Company’s loans payable was $28,041 and $16,721, respectively, which equates to their estimated fair value. The fair value of cash and cash equivalents, which is comprised of a money market fund, is determined based on the net asset value per unit utilizing Level 2 methods and assumptions. As of March 31, 2016 and December 31, 2015, the carrying amounts of the Company's cash and cash equivalents was $3,981 and $3,229, respectively, which equates to their fair value.
The carrying amounts and estimated fair values of the Company’s long-term debt is as follows:
| | | | | | |
| | | | | | |
| | March 31, | | December 31, |
| | 2016 | | 2015 |
Carrying Amount | | $ | 1,795,758 | | $ | 1,779,205 |
Estimated Fair Value | | | 2,020,229 | | | 1,905,393 |
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AQUA AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)
The fair value of long-term debt has been determined by discounting the future cash flows using current market interest rates for similar financial instruments of the same duration utilizing Level 2 methods and assumptions. The Company’s customers’ advances for construction have a carrying value of $86,546 as of March 31, 2016, and $86,934 as of December 31, 2015. Their relative fair values cannot be accurately estimated because future refund payments depend on several variables, including new customer connections, customer consumption levels, and future rate increases. Portions of these non-interest bearing instruments are payable annually through 2026 and amounts not paid by the respective contract expiration dates become non-refundable. The fair value of these amounts would, however, be less than their carrying value due to the non-interest bearing feature.
Note 7 – Net Income per Common Share
Basic net income per common share is based on the weighted average number of common shares outstanding. Diluted net income per common share is based on the weighted average number of common shares outstanding and potentially dilutive shares. The dilutive effect of employee stock-based compensation is included in the computation of diluted net income per common share. The dilutive effect of stock-based compensation is calculated using the treasury stock method and expected proceeds upon exercise or issuance of the stock-based compensation. The treasury stock method assumes that the proceeds from the exercise of stock options are used to purchase the Company’s common stock at the average market price during the period. The following table summarizes the shares, in thousands, used in computing basic and diluted net income per common share:
| | | | | |
| | | | | |
| | Three Months Ended | |
| | March 31, | |
| | 2016 | | 2015 | |
Average common shares outstanding during the period for basic computation | | 177,104 | | 176,888 | |
Dilutive effect of employee stock-based compensation | | 715 | | 904 | |
Average common shares outstanding during the period for diluted computation | | 177,819 | | 177,792 | |
| | | | | |
For the three months ended March 31, 2016 and 2015, all of the Company’s employee stock options were included in the calculations of diluted net income per share as the calculated cost to exercise the stock options was less than the average market price of the Company’s common stock during these periods.
Note 8 – Stock-based Compensation
Under the Company’s 2009 Omnibus Equity Compensation Plan, as amended as of February 27, 2014 (the “2009 Plan”), as approved by the Company’s shareholders to replace the 2004 Equity Compensation Plan (the “2004 Plan”), stock options, stock units, stock awards, stock appreciation rights, dividend equivalents, and other stock-based awards may be granted to employees, non-employee directors, and consultants and advisors. The 2009 Plan authorizes 6,250,000 shares for issuance under the plan. A maximum of 3,125,000 shares under the 2009 Plan may be issued pursuant to stock awards, stock units and other stock-based awards, subject to adjustment as provided in the 2009 Plan. During any calendar year, no individual
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AQUA AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)
may be granted (i) stock options and stock appreciation rights under the 2009 Plan for more than 500,000 shares of Company stock in the aggregate or (ii) stock awards, stock units or other stock-based awards under the 2009 Plan for more than 500,000 shares of Company stock in the aggregate, subject to adjustment as provided in the 2009 Plan. Awards to employees and consultants under the 2009 Plan are made by a committee of the Board of Directors of the Company, except that with respect to awards to the Chief Executive Officer, the committee recommends those awards for approval by the non-employee directors of the Board of Directors. In the case of awards to non-employee directors, the Board of Directors of makes such awards. At March 31, 2016, 3,989,744 shares underlying stock-based compensation awards were still available for grants under the 2009 Plan. No further grants may be made under the 2004 Plan.
Performance Share Units – A performance share unit (“PSU”) represents the right to receive a share of the Company’s common stock if specified performance goals are met over the three-year performance period specified in the grant, subject to exceptions through the respective vesting period, generally three years. Each grantee is granted a target award of PSUs, and may earn between 0% and 200% of the target amount depending on the Company’s performance against the performance goals. The following table provides compensation costs for stock-based compensation related to PSUs:
| | | | | | | |
| | | | | | | |
| | Three Months Ended | |
| | March 31, | |
| | 2016 | | 2015 | |
Stock-based compensation within operations and maintenance expenses | | $ | 525 | | $ | 1,078 | |
Income tax benefit | | | 209 | | | 439 | |
The following table summarizes nonvested PSU transactions for the three months ended March 31, 2016:
| | | | | | |
| | | | | | |
| | | Number | | Weighted |
| | | of | | Average |
| | | Share Units | | Fair Value |
Nonvested share units at December 31, 2015 | | | 424,858 | | $ | 25.78 |
Granted | | | 151,156 | | | 28.89 |
Performance criteria adjustment | | | 26,047 | | | 25.62 |
Forfeited | | | (5,900) | | | 25.89 |
Share units vested | | | 44,625 | | | 26.88 |
Share units issued | | | (189,885) | | | 23.25 |
Nonvested share units at March 31, 2016 | | | 450,901 | | $ | 27.98 |
| | | | | | |
A portion of the fair value of PSUs was estimated at the grant date based on the probability of satisfying the market-based conditions using the Monte Carlo valuation method, which assesses probabilities of various outcomes of market conditions. The other portion of the fair value of the PSUs is based on the fair market value of the Company’s stock at the grant date, regardless of whether the market-based condition is satisfied. The per unit weighted-average fair value at the date of grant for PSUs granted during the three months ended
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AQUA AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)
March 31, 2016 and 2015 was $28.89 and $26.54, respectively. The fair value of each PSU grant is amortized monthly into compensation expense on a straight-line basis over their respective vesting periods, generally 36 months. The accrual of compensation costs is based on our estimate of the final expected value of the award, and is adjusted as required for the portion based on the performance-based condition. The Company assumes that forfeitures will be minimal, and recognizes forfeitures as they occur, which results in a reduction in compensation expense. As the payout of the PSUs includes dividend equivalents, no separate dividend yield assumption is required in calculating the fair value of the PSUs. The recording of compensation expense for PSUs has no impact on net cash flows.
Restricted Stock Units – A restricted stock unit (“RSU”) represents the right to receive a share of the Company’s common stock. RSUs are eligible to be earned at the end of a specified restricted period, generally three years, beginning on the date of grant. The Company assumes that forfeitures will be minimal, and recognizes forfeitures as they occur, which results in a reduction in compensation expense. As the payout of the RSUs includes dividend equivalents, no separate dividend yield assumption is required in calculating the fair value of the RSUs. The following table provides compensation costs for stock-based compensation related to RSUs:
| | | | | | | |
| | | | | | | |
| | Three Months Ended | |
| | March 31, | |
| | 2016 | | 2015 | |
Stock-based compensation within operations and maintenance expenses | | $ | 168 | | $ | 263 | |
Income tax benefit | | | 69 | | | 109 | |
The following table summarizes nonvested RSU transactions for the three months ended March 31, 2016:
| | | | | | |
| | | | | | |
| | | Number | | Weighted |
| | | of | | Average |
| | | Stock Units | | Fair Value |
Nonvested stock units at December 31, 2015 | | | 88,353 | | $ | 24.94 |
Granted | | | 49,636 | | | 32.04 |
Stock units vested and issued | | | (24,318) | | | 23.37 |
Forfeited | | | (1,500) | | | 25.53 |
Nonvested stock units at March 31, 2016 | | | 112,171 | | $ | 28.41 |
The per unit weighted-average fair value at the date of grant for RSUs granted during the three months ended March 31, 2016 and 2015 was $32.04 and $26.26, respectively.
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AQUA AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)
Stock Options – The following table provides the income tax benefit for stock-based compensation related to stock options granted in prior periods:
| | | | | | | |
| | | | | | | |
| | Three Months Ended | |
| | March 31, | |
| | 2016 | | 2015 | |
Income tax benefit | | $ | 216 | | $ | 104 | |
| | | | | | | |
For the three months ended March 31, 2016 and 2015, there were no compensation costs for stock-based compensation related to stock options, as stock options were fully amortized in 2013. Additionally, there were no stock options granted during the three months ended March 31, 2016 or 2015.
The following table summarizes stock option transactions for the three months ended March 31, 2016:
| | | | | | | | | | |
| | | | | | | | | | |
| | | | Weighted | | Weighted | | | |
| | | | Average | | Average | | Aggregate |
| | | | Exercise | | Remaining | | Intrinsic |
| | Shares | | Price | | Life (years) | | Value |
Outstanding at December 31, 2015 | | 659,533 | | $ | 16.62 | | | | | |
Forfeited | | - | | | - | | | | | |
Expired / Cancelled | | (3,436) | | | 16.15 | | | | | |
Exercised | | (143,372) | | | 19.64 | | | | | |
Outstanding and exercisable at March 31, 2016 | | 512,725 | | $ | 15.78 | | 2.5 | | $ | 8,224 |
Stock Awards – On March 31, 2016, the Company granted 3,522 shares of common stock to the non-employee members of the Board of Directors. The fair market value of the shares is $31.94 per share. The shares granted are not subject to any restrictions. In the first quarter of 2016, the Company recognized $112 of compensation expense and an income tax benefit of $47 associated with these grants. There were no stock awards granted to the non-employee members of the Board of Directors during the quarter ended March 31, 2015.
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AQUA AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)
Note 9 – Pension Plans and Other Postretirement Benefits
The Company maintains a qualified defined benefit pension plan (the “Pension Plan”), a nonqualified pension plan and other postretirement benefit plans for certain of its employees. The net periodic benefit cost is based on estimated values and an extensive use of assumptions about the discount rate, expected return on plan assets, the rate of future compensation increases received by the Company’s employees, mortality, turnover, and medical costs. The following tables provide the components of net periodic benefit cost:
| | | | | | | |
| | | | | | | |
| | Pension Benefits |
| | Three Months Ended | |
| | March 31, | |
| | 2016 | | 2015 | |
Service cost | | $ | 826 | | $ | 925 | |
Interest cost | | | 3,285 | | | 3,222 | |
Expected return on plan assets | | | (4,266) | | | (4,674) | |
Amortization of prior service cost | | | 145 | | | 43 | |
Amortization of actuarial loss | | | 1,760 | | | 1,532 | |
Settlement charge | | | 3,028 | | | - | |
Special termination benefit charge | | | 302 | | | - | |
Net periodic benefit cost | | $ | 5,080 | | $ | 1,048 | |
| | | | | | | |
| | Other |
| | Postretirement Benefits |
| | | Three Months Ended | |
| | | March 31, | |
| | 2016 | | 2015 | |
Service cost | | $ | 255 | | $ | 406 | |
Interest cost | | | 750 | | | 758 | |
Expected return on plan assets | | | (711) | | | (730) | |
Amortization of prior service cost | | | (137) | | | (54) | |
Amortization of actuarial loss | | | 267 | | | 354 | |
Net periodic benefit cost | | $ | 424 | | $ | 734 | |
Effective July 1, 2015, the Company added a permanent lump sum option to the form of benefit payments offered to participants of the qualified defined benefit pension plan and non-qualified retirement plans upon retirement or termination. During the first quarter of 2016, the lump sum payments paid to participants who elected this option for payments from the non-qualified retirement plans resulted in a settlement charge. The Company made cash contributions of $2,715 to its Pension Plan during the first three months of 2016, and intends to make cash contributions of $5,430 to the Pension Plan during the remainder of 2016.
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AQUA AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)
Note 10 – Water and Wastewater Rates
During the first three months of 2016, the Company’s operating divisions in Ohio, Texas, and Virginia were granted base rate increases designed to increase total operating revenues on an annual basis by $3,090. Further, during the first three months of 2016, the Company’s operating divisions in Illinois, Pennsylvania (wastewater), and North Carolina received approval to bill infrastructure rehabilitation surcharges designed to increase total operating revenues on an annual basis by $1,365.
Note 11 – Taxes Other than Income Taxes
The following table provides the components of taxes other than income taxes:
| | | | | | | |
| | | | | | | |
| | Three Months Ended | |
| | March 31, | |
| | 2016 | | 2015 | |
Property | | $ | 6,185 | | $ | 6,825 | |
Capital stock | | | 427 | | | 540 | |
Gross receipts, excise and franchise | | | 2,519 | | | 2,442 | |
Payroll | | | 3,337 | | | 3,278 | |
Regulatory assessments | | | 672 | | | 653 | |
Other | | | 1,000 | | | 883 | |
Total taxes other than income | | $ | 14,140 | | $ | 14,621 | |
| | | | | | | |
Note 12 – Segment Information
The Company has identified ten operating segments and has one reportable segment named the “Regulated” segment. The reportable segment is comprised of eight operating segments for the Company’s water and wastewater regulated utility companies which are organized by the states where we provide these services. In addition, two segments are not quantitatively significant to be reportable and are comprised of the Company’s market-based activities: Aqua Resources, Inc. and Aqua Infrastructure, LLC. Aqua Resources provides water and wastewater service through operating and maintenance contracts with municipal authorities and other parties in close proximity to our utility companies’ service territories; offers, through a third party, water and wastewater line repair service and protection solutions to households; inspects, cleans and repairs storm and sanitary wastewater lines; installs and tests devices that prevent the contamination of potable water; designs and builds water and wastewater systems; and provides other market-based water and wastewater services. In addition, Aqua Resources provides liquid waste hauling and disposal services in a business unit that, in December 2015, the Company decided to sell, which is reported as assets held for sale in the Company’s consolidated balance sheets included in this report. Aqua Infrastructure provides non-utility raw water supply services for firms in the natural gas drilling industry. These two segments are included as a component of “Other” in the tables below. Also included in “Other” are corporate costs that have not been allocated to the Regulated segment and intersegment eliminations. Corporate costs include general and administrative expense, and interest expense.
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AQUA AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)
The following table presents information about the Company’s reportable segment:
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Three Months Ended |
| | March 31, 2016 | | March 31, 2015 |
| | Regulated | | Other | | Consolidated | | Regulated | | Other | | Consolidated |
Operating revenues | | $ | 186,006 | | $ | 6,601 | | $ | 192,607 | | $ | 180,564 | | $ | 9,762 | | $ | 190,326 |
Operations and maintenance expense | | | 67,325 | | | 6,216 | | | 73,541 | | | 67,018 | | | 6,171 | | | 73,189 |
Depreciation | | | 32,206 | | | (61) | | | 32,145 | | | 30,438 | | | 62 | | | 30,500 |
Operating income | | | 72,850 | | | (519) | | | 72,331 | | | 68,624 | | | 2,543 | | | 71,167 |
Interest expense, net | | | 18,801 | | | 1,052 | | | 19,853 | | | 17,902 | | | 763 | | | 18,665 |
Allowance for funds used during construction | | | (2,308) | | | - | | | (2,308) | | | (1,182) | | | - | | | (1,182) |
Income tax expense (benefit) | | | 3,673 | | | (666) | | | 3,007 | | | 4,367 | | | 227 | | | 4,594 |
Net income (loss) | | | 52,894 | | | (1,157) | | | 51,737 | | | 47,705 | | | 840 | | | 48,545 |
Capital expenditures | | | 72,389 | | | 595 | | | 72,984 | | | 70,111 | | | 173 | | | 70,284 |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| | | | | | |
| | March 31, | | December 31, |
| | 2016 | | 2015 |
Total assets: | | | | | | |
Regulated | | $ | 5,639,573 | | $ | 5,541,335 |
Other | | | 175,870 | | | 176,538 |
Consolidated | | $ | 5,815,443 | | $ | 5,717,873 |
| | | | | | |
Note 13 – Commitments and Contingencies
The Company is routinely involved in various disputes, claims, lawsuits and other regulatory and legal matters, including both asserted and unasserted legal claims, in the ordinary course of business. The status of each such matter, referred to herein as a loss contingency, is reviewed and assessed in accordance with applicable accounting rules regarding the nature of the matter, the likelihood that a loss will be incurred, and the amounts involved. As of March 31, 2016, the aggregate amount of $14,913 is accrued for loss contingencies and is reported in the Company’s consolidated balance sheet as other accrued liabilities and other liabilities. These accruals represent management’s best estimate of probable loss (as defined in the accounting guidance) for loss contingencies or the low end of a range of losses if no single probable loss can be estimated. For some loss contingencies, the Company is unable to estimate the amount of the probable loss or range of probable losses. While the final outcome of these loss contingencies cannot be predicted with certainty, and unfavorable outcomes could negatively impact the Company, at this time in the opinion of management, the final resolution of these matters are not expected to have a material adverse effect on the Company’s financial position, results of operations or cash flows. Further, the Company has insurance coverage for certain of these loss contingencies, and as of March 31, 2016, estimates that approximately $1,544 of the amount accrued for these matters are probable of recovery through insurance, which amount is also reported in the Company’s consolidated balance sheet as deferred charges and other assets, net.
In addition to the aforementioned loss contingencies, the Company self-insures its employee medical benefit program, and maintains stop-loss coverage to limit the exposure arising from these claims. The
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AQUA AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)
Company’s reserve for these claims totaled $1,496 at March 31, 2016 and represents a reserve for unpaid claim costs, including an estimate for the cost of incurred but not reported claims.
Note 14 – Income Taxes
During the three months ended March 31, 2016, the Company utilized $22 of its Federal net operating loss (“NOL”) carryforward. In addition, during the three months ended March 31, 2016, the Company’s state NOL carryforward increased by $8,473. As of March 31, 2016, the balance of the Company’s Federal NOL was $158,254. The Company believes its Federal NOL carryforward is more likely than not to be recovered and requires no valuation allowance. As of March 31, 2016, the balance of the Company’s gross state NOL was $557,144, a portion of which is offset by a valuation allowance because the Company does not believe the NOLs are more likely than not to be realized. The Company’s Federal and state NOL carryforwards begin to expire in 2032 and 2023, respectively. The Company’s Federal and state NOL carryforwards are reduced by an unrecognized tax position, on a gross basis, of $63,286 and $89,251, respectively. The amounts of the Company’s Federal and state NOL carryforwards prior to being reduced by the unrecognized tax positions were $221,540 and $646,395 respectively. The Company records its unrecognized tax benefit as a reduction to its deferred income tax liability.
In accordance with a 2012 settlement agreement with the Pennsylvania Public Utility Commission, Aqua Pennsylvania expenses, for tax purposes, qualifying utility asset improvement costs, which results in a substantial reduction in income tax expense and greater net income and cash flows. The Company’s effective income tax rate for the first quarter of 2016 and 2015, was 5.5% and 8.6%, respectively.
As of March 31, 2016, the total gross unrecognized tax benefit was $28,208, of which $18,597, if recognized, would affect the Company’s effective tax rate as a result of the regulatory treatment afforded for qualifying infrastructure improvements in Pennsylvania. At December 31, 2015, the Company had unrecognized tax benefits of $28,016.
Accounting rules for uncertain tax positions specify that tax positions for which the timing of resolution is uncertain should be classified as long-term liabilities. Judgment is required in evaluating the Company’s uncertain tax positions and determining the provision for income taxes. Management believes that an adequate provision has been made for any adjustments that may result from tax examinations. Although the timing of income tax audit resolutions and negotiations with taxing authorities is highly uncertain, the Company does not anticipate a significant change to the total amount of unrecognized income tax benefits within the next 12 months.
Note 15 – Recent Accounting Pronouncements
In March 2016, the FASB issued updated accounting guidance on simplifying the accounting for share-based payments, which includes several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The updated guidance is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years, with early adoption available. The Company is evaluating the requirements of the updated guidance to determine the impact of adoption.
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AQUA AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)
In February 2016, the FASB issued updated accounting guidance on accounting for leases, which requires lessees to establish a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. For income statement purposes, leases will be classified as either operating or finance. Operating leases will result in straight-line expense while finance leases will result in a front-loaded expense pattern. The updated accounting guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption available. The Company is evaluating the requirements of the updated guidance to determine the impact of adoption.
In September 2015, the FASB issued updated accounting guidance on simplifying measurement-period adjustment in business combinations, which eliminates the requirement that an acquirer in a business combination account for measurement-period adjustments retrospectively. Instead, an acquirer will recognize a measurement-period adjustment during the period in which it determines the amount of the adjustment. The Company adopted the provisions of this accounting standard, as required on January 1, 2016, and it did not have an impact on its results of operations or financial position.
In April 2015, the FASB issued updated accounting guidance on simplifying the presentation of debt issuance costs, which requires debt issuance costs to be presented in the balance sheet as a direct deduction from the carrying value of the associated debt liability. Previously, debt issuance costs were presented in the balance sheet as a deferred charge. The Company adopted the provisions of this accounting standard as required on January 1, 2016. The adoption of this standard was applied retrospectively and resulted in the reclassification of $23,165 from deferred charges and other assets, net to debt issuance costs, which is reported as a reduction to long-term debt, in the December 31, 2015 Consolidated Balance Sheet.
In August 2014, the FASB issued an accounting standard that will require management to assess an entity’s ability to continue as a going concern for each annual and interim reporting period and to provide related footnote disclosures in circumstances in which substantial doubt exists. The accounting standard is effective in the first annual reporting period ending after December 15, 2016. The Company does not expect the provisions of this accounting standard to have an impact on its results of operations or financial position.
In May 2014, the FASB issued updated accounting guidance on recognizing revenue from contracts with customers, which outlines a single comprehensive model that an entity will apply to determine the measurement of revenue and timing of when it is recognized. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. The updated guidance also requires additional disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. In July 2015, the FASB approved a one year deferral to the original effective date of this guidance. The updated guidance is effective for reporting periods beginning after December 15, 2017, and will be applied retrospectively. The Company is evaluating the requirements of the updated guidance to determine the impact of adoption.
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AQUA AMERICA, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
(In thousands of dollars, except per share amounts)
Aqua America, Inc., which prior to its name change in 2004 was known as Philadelphia Suburban Corporation, was formed in 1968 as a holding company for its primary subsidiary, Aqua Pennsylvania, formerly known as Philadelphia Suburban Water Company. In the early 1990s, we embarked on a growth-through-acquisition strategy focused on water and wastewater operations. Our most significant transactions to date have been the merger with Consumers Water Company in 1999, the acquisition of the regulated water and wastewater operations of AquaSource, Inc. in 2003, the acquisition of Heater Utilities, Inc. in 2004, and the acquisition of American Water Works Company, Inc.’s regulated operations in Ohio in 2012. Since the early 1990s, our business strategy has been primarily directed toward the regulated water and wastewater utility industry, where we have more than quadrupled the number of regulated customers we serve, and has extended our regulated operations from southeastern Pennsylvania to include operations in seven other states. Currently, the Company seeks to acquire businesses in the U.S. regulated sector and to pursue growth ventures in market-based activities that are supplementary and complementary to our regulated businesses.
Beginning in 2010, and substantially completed in 2013, we pursued a portfolio rationalization strategy to focus our operations in areas where we have critical mass and economic growth potential and to divest operations where limited customer growth opportunities exist, or where we are unable to achieve favorable operating results or a return on equity that we consider acceptable. In 2014, we sold our operation in Georgia; in 2013, we sold our operations in Florida; in 2012, we sold our operations in Maine and New York; in 2011, we sold our operations in Missouri; and in 2010, we sold our operations in South Carolina. In connection with the sale of our New York and Missouri operations, we acquired additional utility systems (and customers) in Ohio and Texas, two of the larger states in our portfolio.
The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes.
Financial Condition
During the first three months of 2016, we had $72,984 of capital expenditures, expended $4,461 for the acquisition of water and wastewater utility systems, issued $96,314 of long-term debt, and repaid debt and made sinking fund contributions and other loan repayments of $80,341. The capital expenditures were related to new and replacement water mains, improvements to treatment plants, tanks, hydrants, and service lines, well and booster improvements, and other enhancements and improvements. The issuance of long-term debt was comprised principally of the funds borrowed under our revolving credit facility. In addition, we issued 439,943 shares of the Company’s common stock, and paid $3,905 in cash for the acquisition of Superior Water Company, Inc. as described in Note 3 – Acquisitions.
At March 31, 2016, we had $3,981 of cash and cash equivalents compared to $3,229 at December 31, 2015. During the first three months of 2016, we used the proceeds from the issuance of long-term debt and internally generated funds to fund the cash requirements discussed above and to pay dividends.
At March 31, 2016, our $250,000 unsecured revolving credit facility, which was amended and now expires in February 2021, had $141,690 available for borrowing. At March 31, 2016, we had short-term
Table of Contents
AQUA AMERICA, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
(In thousands of dollars, except per share amounts)
lines of credit of $135,500, of which $107,459 was available for borrowing. One of our short-term lines of credit is an Aqua Pennsylvania $100,000 364-day unsecured revolving credit facility with four banks, which is used to provide working capital, and as of March 31, 2016, $76,798 was available for borrowing.
Our short-term lines of credit of $135,500 are subject to renewal on an annual basis. Although we believe we will be able to renew these facilities, there is no assurance that they will be renewed, or what the terms of any such renewal will be.
The Company’s consolidated balance sheet historically has had a negative working capital position whereby routinely our current liabilities exceed our current assets. Management believes that internally generated funds along with existing credit facilities and the proceeds from the issuance of long-term debt will be adequate to provide sufficient working capital to maintain normal operations and to meet our financing requirements for at least the next twelve months.
Results of Operations
Analysis of First Quarter of 2016 Compared to First Quarter of 2015
Revenues increased by $2,281 or 1.2%, primarily due to additional water and wastewater revenues of $3,564 associated with a larger customer base due to utility acquisitions, an increase in water and wastewater rates of $1,263, and an increase in infrastructure rehabilitation surcharges of $1,124, offset by a decrease in market-based activities revenues of $3,162 and lower customer water consumption. The market-based activities revenues decreased due to the absence in the first quarter of 2016 of a significant short-term wastewater services contract that occurred in the first quarter of 2015.
Operations and maintenance expenses increased by $352 or 0.5%, primarily due to additional operating costs associated with acquired utility systems of $2,410, an increase in the Company’s self-insured employee medical benefit program expense of $915, and an increase in insurance of $773, offset by decreases in market-based activities expenses of $2,147 and water production costs of $1,056.
Depreciation expense increased by $1,645 or 5.4%, primarily due to the utility plant placed in service since March 31, 2015.
Taxes other than income taxes decreased by $481 or 3.3%, primarily due to a decrease in property taxes of $640 resulting from a reduction in property taxes for our Ohio operating subsidiary.
Interest expense increased by $1,188 or 6.4%, primarily due to an increase in average borrowings.
Allowance for funds used during construction (“AFUDC”) increased by $1,126, due to an increase in the average balance of utility plant construction work in progress, to which AFUDC is applied and an increase in the AFUDC rate.
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AQUA AMERICA, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
(In thousands of dollars, except per share amounts)
Equity loss in joint venture decreased by $465 primarily due to a reduction in depreciation expense resulting from the noncash impairment charge recognized by the joint venture on its long-lived assets in the fourth quarter of 2015.
Our effective income tax rate was 5.5% in the first quarter of 2016 and 8.6% in the first quarter of 2015. The effective income tax rate decreased due to the effect of additional tax deductions recognized in the first quarter of 2016 for certain qualifying infrastructure improvements for Aqua Pennsylvania.
Net income increased by $3,192 or 6.6%, primarily as a result of the factors described above.
Impact of Recent Accounting Pronouncements
We describe the impact of recent accounting pronouncements in Note 15, Recent Accounting Pronouncements, of the consolidated financial statements in this report.
