EXHIBIT 13.1
AQUA AMERICA, INC.
SELECTED PORTIONS OF ANNUAL REPORT TO SHAREHOLDERS FOR THE YEAR ENDED
DECEMBER 31, 2004
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(In thousands of dollars, except per share amounts)
FORWARD-LOOKING STATEMENTS
This report by Aqua America, Inc. ("Aqua America," "we" or "us")
contains, in addition to historical information, forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements involve risks, uncertainties and other factors,
many of which are outside our control, that may cause our actual results,
performance or achievements to be materially different from any future results,
performance or achievements expressed or implied by these forward-looking
statements. In some cases you can identify forward-looking statements where
statements are preceded by, followed by or include the words "believes,"
"expects," "anticipates," "plans," "future," "potential" or the negative of such
terms or similar expressions. Forward-looking statements in this report,
include, but are not limited to, statements regarding:
o recovery of capital expenditures and expenses in rates;
o projected capital expenditures and related funding requirements;
o dividend payment projections;
o future financing plans;
o future pension contributions;
o opportunities for future acquisitions, the success of pending acquisitions
and the impact of future acquisitions;
o acquisition-related costs and synergies;
o the capacity of our water supplies and facilities;
o general economic conditions;
o The impact of geographic diversity on our exposure to unusual weather; and
o The impact of accounting pronouncements.
Because forward-looking statements involve risks and uncertainties,
there are important factors that could cause actual results to differ materially
from those expressed or implied by these forward-looking statements, including
but not limited to:
o changes in general economic, business and financial market conditions;
o changes in government regulations and policies, including environmental and
public utility regulations and policies;
o changes in environmental conditions, including those that result in water use
restrictions;
o abnormal weather conditions;
o changes in capital requirements;
o changes in our credit rating;
o our ability to integrate businesses, technologies or services which we may
acquire;
o our ability to manage the expansion of our business;
o the extent to which we are able to develop and market new and improved
services;
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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)
o the effect of the loss of major customers;
o unanticipated capital requirements;
o our ability to retain the services of key personnel and to hire qualified
personnel as we expand;
o increasing difficulties in obtaining insurance and increased cost of
insurance;
o cost overruns relating to improvements or the expansion of our operations;
and
o civil disturbance or terroristic threats or acts.
Given these uncertainties, you should not place undue reliance on these
forward-looking statements. You should read this report with the understanding
that our actual future results may be materially different from what we expect.
These forward-looking statements represent our estimates and assumptions only as
of the date of this report. Except for our ongoing obligations to disclose
material information under the federal securities laws, we are not obligated to
update these forward-looking statements, even though our situation may change in
the future. We qualify all of our forward-looking statements by these cautionary
statements.
GENERAL INFORMATION
Name Change
On January 16, 2004, we changed our name to Aqua America, Inc. from
Philadelphia Suburban Corporation. In addition, we changed our ticker symbol to
WTR from PSC on the New York Stock Exchange and Philadelphia Stock Exchange on
January 20, 2004.
Overview
Aqua America, Inc. is the holding company for regulated utilities
providing water or wastewater services to more than 2.5 million people in
Pennsylvania, Ohio, North Carolina, Illinois, Texas, New Jersey, Florida,
Indiana, Virginia, Maine, Missouri, New York and South Carolina. Our largest
operating subsidiary, Aqua Pennsylvania, Inc. - formerly Pennsylvania Suburban
Water Company, accounts for approximately 57% of our operating revenues and
provides water or wastewater services to approximately 1.3 million residents in
the suburban areas north and west of the City of Philadelphia and in 21 other
counties in Pennsylvania. Our other subsidiaries provide similar services in 12
other states. In addition, we provide water and wastewater service through
operating and maintenance contracts with municipal authorities and other parties
close to our operating companies' service territories. We are the largest
U.S.-based publicly-traded water utility based on number of people served.
The mission of the investor-owned water utility industry is to provide
quality and reliable water service at an affordable price for the customer, and
provide a fair return to its shareholders. A number of challenges face the
industry, including:
o strict environmental, health and safety standards;
o the need for substantial capital investment;
o economic regulation by state, and/or in some cases local, government; and
o the impact of weather and drought conditions on water sales demand.
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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. strives to achieve the industry mission by effective
planning and efficient use of its resources to meet the industry challenges. We
maintain a rate case management capability to pursue timely and adequate returns
on the capital investments that we make in improving or replacing water mains,
treatment plants and other infrastructure. This factor is important in our
continued profitability and in providing a fair return to our shareholders, and
thus providing access to capital markets to help fund these investments. Often
these utility investments are required by a changed federal or state
environmental standard, to improve our ability to deliver quality customer
service, or to assist in our ability to supply water in sufficient quantities
for future demand or when experiencing drought conditions. A strategy to meet
the above challenges is to actively explore opportunities to expand our utility
operations through acquisitions of water and wastewater utilities either in
areas adjacent to our existing service areas or in new service areas. This
growth-through-acquisition strategy allows us to operate more efficiently and
provides an important source for possible future growth. The ability to
successfully execute this strategy and meet the industry challenges is largely
due to our qualified and trained workforce, which we strive to retain by
treating employees fairly and providing our employees with development and
growth opportunities.
We believe that acquisitions will continue to be an important source of
growth for us. With more than 50,000 community water systems in the U.S., 84% of
which serve less than 3,300 customers, the water industry is the most fragmented
of the major utility industries (telephone, natural gas, electric, water and
wastewater). In the states where we operate, we believe there are over 22,000
public water systems of widely varying size, with the majority of the population
being served by government-owned water systems.
Although not as fragmented as the water industry, the wastewater
industry in the U.S. also presents opportunities for consolidation. According to
the U.S. Environmental Protection Agency's (EPA) most recent survey of
publicly-owned wastewater treatment facilities in 2000, there are approximately
16,000 such facilities in the nation serving approximately 72% of the U.S.
population. The remaining population represents individual homeowners with their
own treatment facilities; for example, community on-lot disposal systems and
septic tank systems. The vast majority of wastewater facilities are
government-owned rather than privately-owned. The EPA survey also indicated that
there are approximately 6,600 wastewater facilities in operation or planned in
the 13 states where we operate.
Because of the fragmented nature of the water and wastewater utility
industries, we believe that there are many potential water and wastewater system
acquisition candidates throughout the United States. We believe the factors
driving the consolidation of these systems are:
o the benefits of economies of scale;
o increasingly stringent environmental regulations;
o the need for capital investment; and
o the need for technological and managerial expertise.
On June 1, 2004, we acquired the capital stock of Heater Utilities,
Inc. for $48,000 in cash and the assumption of long-term debt of $19,219 and
short-term debt of $8,500. The acquired operation provides water and wastewater
service to over 50,000 water and wastewater customers primarily in the areas of
suburban Raleigh, Charlotte, Gastonia and Fayetteville, North Carolina. On June
30, 2004, we acquired certain utility assets of Florida Water Services
Corporation, comprised of 63 water and wastewater systems located in central
Florida for $14,747 in cash. In accordance with Florida procedures, the
acquisition remains subject to regulatory approval by the Florida Public Service
Commission. This process is not expected to be completed prior to September
2005. The operating results of these acquisitions have been included in our
consolidated financial statements beginning on the respective acquisition dates.
Under the terms of the purchase agreement, the Commission's review process may
result in an adjustment of the final purchase price based on the Commission's
determination of plant investment for the systems. The final purchase price is
not expected to result in the recognition of goodwill.
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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)
On July 31, 2003, we completed the acquisition of four operating water
and wastewater subsidiaries of AquaSource, Inc., a subsidiary of DQE, Inc.,
including selected, integrated operating and maintenance contracts and related
assets, for $178,428 in cash, as adjusted for a purchase price reduction
received in August 2004 of $12,289 pursuant to the purchase agreement. The
acquired operations of AquaSource serve over 130,000 water and wastewater
customer accounts in 11 states; including the Connecticut and Kentucky
operations which were subsequently sold to other parties. The operating results
of AquaSource have been included in our consolidated financial statements
beginning August 1, 2003. Please refer to the section captioned "Acquisitions"
for an expanded discussion of acquisitions.
We are actively exploring other opportunities to expand our water and
wastewater utility operations through acquisitions or otherwise. We intend to
continue to pursue acquisitions of municipally-owned and investor-owned water
and wastewater systems of all sizes that provide services in areas adjacent to
our existing service territories or in new service areas.
Following are our selected five-year financial statistics:
Years ended December 31, 2004 (a) 2003 (b) 2002 (c) 2001 2000 (d)
- ------------------------------------------------------------------------------------------------------------------
Operating revenues $442,039 $367,233 $322,028 $307,280 $274,014
==================================================================================================================
Operations and maintenance expense $178,345 $140,602 $117,735 $111,885 $101,741
==================================================================================================================
Net income available to common stock $ 80,007 $ 70,785 $ 67,154 $ 60,005 $ 52,784
==================================================================================================================
Capital expenditures $195,736 $163,320 $136,164 $124,088 $129,740
==================================================================================================================
OPERATING STATISTICS
Selected operating results as a
percentage of operating revenues:
Operations and maintenance 40.3% 38.3% 36.6% 36.4% 37.1%
Depreciation and amortization 13.3% 14.0% 13.8% 13.1% 12.4%
Taxes other than income taxes 6.2% 5.9% 6.0% 6.8% 8.2%
Interest expense, net 11.0% 12.2% 12.5% 11.9% 12.9%
Net income available to common stock 18.1% 19.3% 20.9% 19.5% 19.3%
==================================================================================================================
Effective tax rates 39.4% 39.3% 38.5% 39.3% 39.2%
==================================================================================================================
(a) Net income available to common stock and net income includes the gain of
$1,522 ($2,342 pre-tax) realized on the sale of our Geneva, Ohio water system.
The gain is reported in the 2004 consolidated statement of income as a reduction
to operations and maintenance expense.
(b) 2003 includes five months of financial results for the AquaSource operations
acquired in July 2003.
(c) Net income available to common stock and net income includes the gain of
$3,690 ($5,676 pre-tax) realized on the sale of a portion of our Ashtabula, Ohio
water system.
(d) Net income available to common stock and net income includes the gain of
$2,236 ($4,041 pre-tax) for the partial recovery of the merger costs related to
the merger with Consumers Water Company.
We consider the following nonfinancial measure and financial measures
to be the fundamental basis by which we evaluate our performance: number of
customers, operating revenues, net income and our dividend rate on common stock.
In addition, we consider other key financial measures in evaluating our
operating results: the ratio of operations and maintenance expense compared to
operating revenues (this percentage is termed "operating expense ratio"); return
on revenues (net income divided by operating revenues); and earnings before
interest, taxes, depreciation and amortization ("EBITDA"). These measurements
are reviewed regularly and compared to historical periods as well as our
operating budget as approved by the Aqua America, Inc. Board of Directors.
4
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)
Our operating expense ratio is one measure that we use to evaluate our
operating efficiency and management effectiveness. As reported in the above
table and as anticipated, our operating expense ratio increased for 2004 over
2003, and 2003 as compared to 2002 as a result of the additional operating costs
associated with the AquaSource acquisition which closed on July 31, 2003. Our
2004 results reflect a full twelve months of operating results for this
acquisition and only five months in 2003. The business model of the acquired
AquaSource operations, generally referred to as our Aqua South operations, are
different from the rest of the Aqua America operations. The Aqua South
operations are comprised of approximately 600 small systems, which are generally
clustered in regions to achieve some level of operating efficiency. However, the
small, separate systems of the Aqua South operations results in the additional
operating revenues generated by the Aqua South operations being accompanied by a
higher ratio of operations and maintenance expenses than the level Aqua America
experiences in the rest of the Aqua America operations. The Aqua South
operations can be characterized as having relatively-higher fixed costs to
operate in contrast to the rest of the Aqua America operations which generally
consist of larger, interconnected systems resulting in higher fixed capital
costs (utility plant investment) and lower operating costs per customer. For the
twelve-month period ending June 30, 2003, the last reporting period before the
July 31, 2003 closing of AquaSource, our operating expense ratio declined to
36.5%, from 36.6% for the year ended December 31, 2002. We are implementing
management systems over time that will allow us to further control costs and
improve efficiencies, but the effect of this acquisition will be to increase our
overall operating expense ratio from the levels experienced during the preceding
five years. Consequently, as anticipated our return on revenues, net income
divided by operating revenues, in 2004 was lower than in the previous four years
as a result of the impact of the higher cost of Aqua South's operations.
Following are our selected five-year operating and sales statistics:
Years ended December 31, 2004 2003 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------
Customers Residential water 702,367 624,355 535,506 526,776 512,442
Commercial water 33,720 33,015 30,355 29,745 29,317
Industrial water 1,365 1,397 1,423 1,454 1,446
Other water 15,700 20,483 16,466 9,947 9,500
Wastewater 82,360 70,241 21,724 19,615 12,441
-------------------------------------------------------------------------------------------------
Total 835,512 749,491 605,474 587,537 565,146
=================================================================================================
Operating Residential water $ 264,910 $218,487 $197,190 $ 188,303 $ 170,597
Revenues (a) Commercial water 65,605 61,343 55,962 53,103 47,109
Industrial water 17,377 17,675 17,221 16,141 14,943
Other water 44,593 40,048 36,255 35,681 29,582
Wastewater 35,931 17,874 8,210 6,960 5,414
Other 13,623 11,806 7,190 7,092 6,369
-------------------------------------------------------------------------------------------------
Total $ 442,039 $367,233 $322,028 $ 307,280 $ 274,014
=================================================================================================
(a) 2003 includes five months of financial results for the operations acquired
in the AquaSource acquisition.
5
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)
RESULTS OF OPERATIONS
Our net income has grown at an annual compound rate of approximately
17.1% during the five-year period ended December 31, 2004. The five year annual
compound growth rate is higher than the rate typically experienced due to the
base year 1999 results including the after-tax merger costs of $8,596 associated
with the Consumers Water Company merger. As a comparison, our net income for the
periods ended December 31, 2004 has grown at annual compound rate of
approximately 10.1% during the past six years, 11.0% during the past four years,
and 10.0% during the past three years. During the past five years, operating
revenues grew at a compound rate of 11.5% and total expenses, exclusive of
income taxes, grew at a compound rate of 11.0%.
Operating Revenues
The growth in revenues over the past five years is a result of
increases in both the customer base and in water rates. The number of customers
increased at an annual compound rate of 8.8% in the past five years primarily as
a result of acquisitions of water and wastewater systems, including the mid-year
2004 Heater and Florida Water Services acquisitions, and the AquaSource
acquisition completed July 2003. Acquisitions made during the five-year period
ended December 31, 2004 have provided water and wastewater revenues of
approximately $90,187 in 2004, $34,960 in 2003 and $8,758 in 2002. Excluding the
effect of acquisitions, our customer base increased at a five-year annual
compound rate of 1.2%. Rate increases implemented during the past three years
have provided additional operating revenues of approximately $15,800 in 2004,
$19,900 in 2003 and $14,700 in 2002. In addition to regulated water and
wastewater operating revenues, we had other non-regulated revenues that were
primarily associated with operating and maintenance contracts, and data
processing service fees of $13,623 in 2004, $11,806 in 2003 and $7,190 in 2002.
The increases in 2004 and 2003 over the previous year resulted primarily from
the additional revenues from contract operations associated with the July 2003
AquaSource acquisition.
Economic Regulation - Most of our water and wastewater utility operations are
subject to regulation by their respective state regulatory commissions, which
have broad administrative power and authority to regulate rates and charges,
determine franchise areas and conditions of service, approve acquisitions and
authorize the issuance of securities. A small number of our operations are
subject to rate regulation by county or city government. The profitability of
our utility operations is influenced a great extent by the timeliness and
adequacy of rate allowances in the various states in which we operate.
Accordingly, we maintain a rate case management capability to provide that the
tariffs of the utility operations reflect, to the extent practicable, the timely
recovery of increases in costs of operations, capital, taxes, energy, materials
and compliance with environmental regulations. In assessing our rate case
strategy, we consider the amount of utility plant additions and replacements
made since the previous rate decision, the changes in the cost of capital,
changes in the capital structure and changes in other costs. Based on these
assessments, our utility operations periodically file rate increase requests
with their respective state regulatory commissions.
On August 5, 2004, the Pennsylvania Public Utility Commission (PAPUC)
granted our Pennsylvania operating subsidiary a $13,800 base rate increase. The
rates in effect at the time of the filing included $11,200 in Distribution
System Improvement Charges ("DSIC") or 5.0% above the prior base rates.
Consequently, the total base rates increased by $25,000 and the DSIC was reset
to zero. On August 1, 2002, the PAPUC granted our Pennsylvania operating
subsidiary a $21,226 base rate increase. The rates in effect at the time of the
filing included $9,400 in DSIC at 5.0%. Consequently, the total base rates
increased by $30,626 and the DSIC was reset to zero.
In May 2004, our operating subsidiary in Texas filed an application with
the Texas Commission on Environmental Quality to increase rates by $11,920 over
a multi-year period. The application seeks to increase annual revenues in phases
and is accompanied by a plan to defer and amortize a portion of our
depreciation, operating and other tax expense over a similar multi-year period,
such that the annual impact on operating income approximates the requested
amount. The application is currently pending before the Commission. We commenced
billing for the requested rates and implemented the deferral plan in August
2004, in accordance with authorization from the Texas Commission on
Environmental Quality in July 2004. The additional revenue billed and collected
prior to the final ruling are subject to refund based on the outcome of the
ruling. The revenue recognized and the expenses deferred by us reflect an
estimate of the final outcome of the ruling.
6
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)
Our operating subsidiaries located in other states received rate
increases representing estimated annualized revenues of $6,673 in 2004 resulting
from fourteen rate decisions, $1,275 in 2003 resulting from eight rate decisions
and $3,024 in 2002 resulting from thirteen rate decisions. Revenues from these
increases realized in the year of grant were approximately $3,995 in 2004, $839
in 2003 and $1,403 in 2002. These operating subsidiaries currently have eleven
rate requests in process requesting a $6,513 increase in annual revenues. These
requests are currently under review by the respective state regulatory
commissions. During 2005, we intend to file twenty-two rate requests requesting
an aggregate of approximately $18,682 of increased annual revenues.
Revenue Surcharges - Four states in which we operate permit water utilities, and
in some states wastewater utilities, to add a surcharge to their water or
wastewater bills to offset the additional depreciation and capital costs
associated with certain capital expenditures related to replacing and
rehabilitating infrastructure systems. Prior to these mechanisms being approved,
water and wastewater utilities absorbed all of the depreciation and capital
costs of these projects between base rate increases without the benefit of
additional revenues. The gap between the time that a capital project is
completed and the recovery of its costs in rates is known as regulatory lag. The
infrastructure rehabilitation surcharge mechanism is intended to substantially
reduce regulatory lag which often acted as a disincentive to water and
wastewater utilities to rehabilitate their infrastructure. In addition, our
subsidiaries in certain states use a surcharge or credit on their bill to
reflect certain allowable changes in costs until such time as these costs are
fully incorporated in base rates.
Currently, Pennsylvania, Illinois, Ohio and Indiana allow for the use of
infrastructure rehabilitation surcharges. In Pennsylvania, this mechanism is
referred to as a DSIC. These mechanisms typically adjust periodically based on
additional qualified capital expenditures completed or anticipated in a future
period. The infrastructure rehabilitation surcharge is capped as a percentage of
base rates, generally 5% of base rates, and is reset to zero when new base rates
that reflect the costs of those additions become effective or when a utility's
earnings exceed a regulatory benchmark. Infrastructure rehabilitation surcharges
provided revenues of $7,817 in 2004, $8,147 in 2003 and $5,518 in 2002.
Sendout - "Sendout" represents the quantity of treated water delivered to our
distribution systems. We use sendout as an indicator of customer demand. Weather
conditions tend to impact water consumption, particularly in our northern
service territories during the late spring and summer months when nonessential
and recreational use of water is at its highest. Consequently, a higher
proportion of annual operating revenues is realized in the second and third
quarters. In general during this period, an extended period of dry weather
increases water consumption, while above average rainfall decreases water
consumption. Also, an increase in the average temperature generally causes an
increase in water consumption. Conservation efforts, construction codes which
require the use of low flow plumbing fixtures, as well as mandated water use
restrictions in response to drought conditions, also affect water consumption.
The geographic diversity of our customer base helps reduce our exposure
to extreme or unusual weather conditions in any one area of our service
territory. Our geographic diversity has continued to widen as a result of the
Heater and Florida Water acquisitions which closed in mid-year 2004 and the
AquaSource acquisition which closed in July 2003. During the year ended December
31, 2004, which included only the partial year operating revenues from the
Heater and Florida Water acquisitions, our operating revenues were derived
principally from the following states: 57% in Pennsylvania, 9% in Ohio, 7% in
Illinois, 7% in Texas, 5% in New Jersey, and 4% in North Carolina.
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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)
On occasion, drought warnings and water use restrictions are issued by
governmental authorities for portions of our service territories in response to
extended periods of dry weather conditions. The timing and duration of the
warnings and restrictions can have an impact on our water revenues and net
income. In general, water consumption in the summer months is affected by
drought warnings and restrictions to a higher degree because nonessential and
recreational use of water is highest during the summer months, particularly in
our northern service territories. At other times of the year, warnings and
restrictions generally have less of an effect on water consumption. During the
period from November 2001 to December 2002, at various times in specific
counties and to varying degrees, drought warnings or drought emergencies were
declared by the Commonwealth of Pennsylvania for substantial portions of our
Pennsylvania service territories. A drought warning calls for a 10 to 15 percent
voluntary reduction of water use, particularly non-essential uses of water. A
drought emergency imposes a ban on nonessential water use. Water use
restrictions were also imposed and relaxed at various times during 2002 in our
service territories in New Jersey. Currently there are no drought warnings or
restrictions in any of the areas we serve.
Operations and Maintenance Expenses
Operations and maintenance expenses totaled $178,345 in 2004, $140,602
in 2003 and $117,735 in 2002. Most elements of operating costs are subject to
the effects of inflation, and changes in the number of customers served, and
several elements are subject to the effects of changes in water consumption,
weather and the degree of water treatment required due to variations in the
quality of the raw water. The principal elements of operating costs are labor
and employee benefits, electricity, chemicals, maintenance expenses and
insurance costs. Electricity and chemical expenses vary in relationship to water
consumption, raw water quality, and to a lesser extent the competitive electric
market in some of the states in which we operate. Maintenance expenses are
sensitive to extremely cold weather, which can cause water mains to rupture.
Operations and maintenance expenses increased in 2004 as compared to 2003 by
$37,743 or 26.8% due to added operating costs associated with acquisitions of
$36,123, additional postretirement costs of $2,110, increased accounting expense
of $1,496 for assessing internal control effectiveness under the Sarbanes-Oxley
Act and higher water production expenses. Partially offsetting these increases
were lower insurance costs due to the favorable settlement of insurance claims
during 2004, and the gain on the sale of the Geneva, Ohio water system of
$2,342. In the consolidated statement of income for 2004, the gain on the sale
of the Geneva water system is reported as a component of the line titled
operations and maintenance expense. The impact of acquisitions is primarily the
result of the effect of AquaSource for the full twelve-month period versus five
months in 2003, and the mid-year 2004 acquisitions of Heater and the Florida
Water Services systems.
Operations and maintenance expenses increased in 2003 as compared to
2002 by $22,867 or 19.4% due to additional operating costs associated with
acquisitions of $18,526, primarily from AquaSource, higher postretirement costs,
and additional maintenance costs, offset in part by reduced bad debt expense.
The postretirement benefits expense increase resulted principally from higher
pension costs and increased retiree medical costs. The increased maintenance
expenses are primarily a result of additional main break repairs resulting from
the relatively harsh winter weather experienced in early 2003 in our northern
service territory.
Depreciation and Amortization Expenses
Depreciation expense was $54,564 in 2004, $48,522 in 2003 and
$41,424 in 2002, and has increased principally as a result of the significant
capital expenditures made to expand and improve our utility facilities, and as a
result of acquisitions of water systems.
Amortization expense was $4,300 in 2004, $2,941 in 2003 and $2,898 in
2002. The increase in 2004 and 2003 is due to the amortization of the costs
associated with, and other costs being recovered in, various rate filings.
Expenses associated with filing rate cases are deferred and amortized over
periods that generally range from one to three years.
8
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)
Taxes Other than Income Taxes
Taxes other than income taxes increased by $5,989 or 27.7% in
2004 as compared to 2003 and $2,140 or 11.0% in 2003 as compared to 2002. The
increase in both 2004 and 2003 is due to additional taxes associated with
acquisitions and increases in state taxes. The other taxes associated with
acquisitions resulted from the effect of the July 2003 AquaSource acquisition
for a twelve-month period in 2004 as compared to the five-month period in 2003,
and the mid-year 2004 acquisitions of Heater Utilities and the systems of
Florida Water.
Interest Expense, net
Net interest expense was $48,679 in 2004, $44,662 in 2003 and
$40,396 in 2002. Interest income of $1,762 in 2004, $395 in 2003 and $287 in
2002 was netted against interest expense. Interest expense increased in 2004 and
in 2003 primarily as a result of higher levels of borrowings, offset partially
by the effects of decreased interest rates on borrowings. The higher level of
average borrowings in 2004 and 2003 was used to finance the acquisition of
AquaSource in July 2003, the Heater and Florida Water acquisitions in mid-year
2004, and capital expenditures. Interest income increased in 2004 due to $532 of
interest income in connection with the arbitration award related to the final
purchase price for the AquaSource acquisition received in 2004 and additional
interest income associated with acquisitions. Interest expense during 2004 was
favorably impacted by a reduction in the weighted cost of long-term debt from
6.19% at December 31, 2003 to 6.00% at December 31, 2004.
Allowance for Funds Used During Construction
The allowance for funds used during construction (AFUDC) was
$2,304 in 2004, $2,127 in 2003 and $1,389 in 2002 and has varied over the years
as a result of changes in the average balance of utility plant construction work
in progress (CWIP), to which AFUDC is applied, and to changes in the AFUDC rate.
The increase in 2004 is due to an increase in the average balance of CWIP to
which AFUDC is applied. The increase in 2003 is due to an increase in the AFUDC
rate as a result of tax-exempt borrowings for our multi-year infrastructure
rehabilitation plan and an increase in the average balance of CWIP.
Gain on Sale of Water System
Gain on sale of water system represents the gain realized on the
December 2002 sale of a portion of the Ashtabula, Ohio water system to the
county government. The sale provided $12,118 of net proceeds and resulted in
2002 pre-tax gain of $5,676. The gain realized on the December 2004 sale of the
Geneva, Ohio water system to the City of Geneva of $2,342 is reported in the
consolidated statement of income as a component of the line titled operations
and maintenance expense.
Gain on Sale of Other Assets
Gain on sale of other assets totaled $1,272 in 2004, $5,692 in 2003 and
$2,079 in 2002 and consisted of gains on land and marketable securities sales.
Gain on sale of land totaled $869 in 2004, $5,153 in 2003 and $900 in 2002. Gain
on sale of marketable securities totaled $403 in 2004, $539 in 2003 and $1,179
in 2002.
Income Taxes
Our effective income tax rate was 39.4% in 2004, 39.3% in 2003 and 38.5%
in 2002. The changes in the effective tax rates in 2004 and 2003 are due to
differences between tax deductible expenses and book expenses.
9
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)
Summary
Operating income was $177,234 in 2004, $153,561 in 2003 and
$140,504 in 2002 and net income available to common stock was $80,007 in 2004,
$70,785 in 2003 and $67,154 in 2002. Diluted income per share was $0.85 in 2004,
$0.79 in 2003 and $0.78 in 2002. The changes in the per share income in 2004 and
2003 over the previous years were due to the aforementioned changes in income
and impacted by a 5.6% increase in the average number of common shares
outstanding during 2004 and a 3.1% increase in the average number of common
shares outstanding during 2003, respectively. The increase in the number of
shares outstanding in 2004 and 2003 is primarily a result of the additional
shares issued in common share offerings and through our dividend reinvestment
plan, employee stock purchase plan and equity compensation plan.
Although we have experienced increased income in the recent past,
continued adequate rate increases reflecting increased operating costs and new
capital investments are important to the future realization of improved
profitability.
Fourth Quarter Results
Net income available to common stock was $22,474 in the fourth quarter
of 2004 and $18,606 in the same period of 2003. The change in net income is due
to a $14,230 increase in operating revenues, offset by increased operations and
maintenance expense of $3,373, increased interest expense of $1,418, a lower
gain on sales of other assets of $973 and increased amortization expense of
$514. The increase in operating revenues was a result of additional revenues of
$9,006 resulting from an increase in water rates granted to our operating
subsidiaries, and the additional revenues from acquisitions, offset partially by
reduced infrastructure rehabilitation surcharge revenue of $2,036. The reduction
in infrastructure rehabilitation surcharge revenues is due to the August 2004
Pennsylvania rate increase which resulted in the DSIC being reset to zero
concurrent with the increase in base water rates. The higher operations and
maintenance expense is due primarily to the additional operating costs
associated with acquisitions, offset partially by the gain on the December 2004
sale of the Geneva water system of $2,342, and reduced insurance costs.
Effects of Inflation
As a regulated enterprise, our rates are established to provide recovery
of costs and a return on our investment. Recovery of the effects of inflation
through higher water rates is dependent upon receiving adequate and timely rate
increases. However, rate increases are not retroactive and often lag increases
in costs caused by inflation. During periods of moderate to low inflation, as
has been experienced for the past several years, the effects of inflation on our
operating results are not significant.
Security
In light of concerns regarding security in the wake of the September 11,
2001 terrorist attacks, we have increased security measures at our facilities.
These increased security measures were not made in response to any specific
threat. We are in contact with federal, state and local authorities and industry
trade associations regarding information on possible threats and security
measures for water utility operations. The cost of the increased security
measures, including capital expenditures, is expected to be recoverable in water
rates and is not expected to have a material impact on our results from
operations or financial condition.
10
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)
FINANCIAL CONDITION
Cash Flow and Capital Expenditures
Net operating cash flow, dividends paid on common stock, capital
expenditures, including allowances for funds used during construction, and
expenditures for acquiring water and wastewater systems for the five years ended
December 31, 2004 were as follows:
- ------------------------------------------------------------------------------------------------
Net Operating Common Capital Acquisitions of
Cash Flow Dividends Expenditures Utility Systems
- ------------------------------------------------------------------------------------------------
2000 $ 86,972 $ 30,406 $ 129,740 $ 3,546
2001 102,165 34,234 124,088 9,517
2002 121,560 36,789 136,164 8,914
2003 143,373 39,917 163,320 192,331
2004 173,603 45,807 195,736 54,300
- ------------------------------------------------------------------------------------------------
$ 627,673 $ 187,153 $ 749,048 $ 268,608
================================================================================================
Included in capital expenditures for the five-year period are:
expenditures for the modernization and replacement of existing treatment plants,
new water mains and customer service lines, rehabilitation of existing water
mains and hydrants, and water meters. During this five-year period, we received
$45,494 of customer advances and contributions in aid of construction to finance
new water mains and related facilities which are not included in the capital
expenditures presented in the above table. In addition, during this period, we
have made sinking fund contributions and retired debt in the amount of $163,689,
retired $1,760 of preferred stock, and have refunded $23,550 of customer
advances for construction. Common dividends increased during the past five years
as a result of an annual increase in the common dividends declared and paid and
an increase in the shares outstanding during the period.
Our planned 2005 capital program, exclusive of the costs of new mains
financed by advances and contributions in aid of construction, is estimated to
be $262,400 of which $66,400 is for infrastructure rehabilitation
surcharge-qualified projects. We have increased our capital spending for
infrastructure rehabilitation in response to the infrastructure rehabilitation
surcharge mechanisms, and should these mechanisms be discontinued for any
reason, which is not anticipated, we would re-evaluate the magnitude our capital
program. Our 2005 capital program, along with $50,195 of sinking fund
obligations and debt maturities, and $33,444 of other contractual cash
obligations, as reported in the section captioned "Contractual Obligations", is
expected to be financed through internally-generated funds, our revolving credit
facilities, the issuance of equity and the issuance of new long-term debt.
Future utility construction in the period 2006 through 2009, including
recurring programs, such as the ongoing replacement of water meters, water
treatment plant upgrades, storage facility renovations, the rehabilitation of
water mains and additional transmission mains to meet customer demands,
exclusive of the costs of new mains financed by advances and contributions in
aid of construction, is estimated to require aggregate expenditures of
approximately $700,000. We anticipate that less than one-half of these
expenditures will require external financing of debt and the additional issuance
of common stock through our dividend reinvestment and stock purchase plans and
possible future public equity offerings. We expect to refinance $86,263 of
sinking fund obligations and debt maturities during this period as they become
due with new issues of long-term debt. The estimates discussed above do not
include any amounts for possible future acquisitions of water systems or the
financing necessary to support them.
11
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)
Our primary source of liquidity is cash flows from operations,
borrowings under various short-term lines of credit and other credit facilities,
and customer advances and contributions in aid of construction. Our cash flow
from operations, or internally-generated funds, is impacted by the timing of
rate relief and water consumption. We fund our capital and acquisition programs
through internally-generated funds, supplemented by short-term borrowings. Over
time, we refinance our short-term borrowings with long-term debt and proceeds
from the issuance of common stock. The ability to finance our future
construction programs, as well as our acquisition activities, depends on our
ability to attract the necessary external financing and maintain
internally-generated funds. Rate orders permitting compensatory rates of return
on invested capital and timely rate adjustments will be required by our
operating subsidiaries to achieve an adequate level of earnings and cash flow to
enable them to secure the capital they will need and to maintain satisfactory
debt coverage ratios.
Acquisitions
During the past five years, we have expended cash of $268,608 and issued
1,317,017 shares of common stock, valued at $16,400 at the time of the
acquisition, related to the acquisitions of utility systems, primarily water
utilities and some wastewater utilities. The operating results of these
acquisitions have been included in our consolidated financial statements
beginning on the respective acquisition date.
Pursuant to our strategy to grow through acquisitions, on June 1, 2004,
we acquired the capital stock of Heater Utilities, Inc. for $48,000 in cash and
the assumption of long-term debt of $19,219 and short-term debt of $8,500. The
acquired operation provides water and wastewater service to over 50,000 water
and wastewater customers primarily in the areas of suburban Raleigh, Charlotte,
Gastonia and Fayetteville, North Carolina. For the fiscal year ended December
31, 2003, Heater had operating revenues of $19,489. The acquisition was
accounted for as a purchase and accordingly, we recorded goodwill of $18,842. In
2004, as part of the North Carolina Utilities Commission approval process for
this acquisition, the Commission approved a mechanism through which we could
recover up to two-thirds of the goodwill through customer rates in the future
upon achieving certain objectives. We intend to pursue these objectives to
facilitate recognition of this premium in customer rates. However, there can be
no assurance that we will be able to achieve these objectives and recover such
amount of goodwill, if any.
On June 30, 2004, we acquired certain utility assets of Florida Water
Services Corporation, comprised of 63 water and wastewater systems located in
central Florida for $14,747 in cash, which is less than the depreciated original
cost of these assets. In accordance with Florida procedures, the acquisition
remains subject to regulatory approval by the Florida Public Service Commission
and this process is not expected to be completed prior to September 2005. Under
the terms of the purchase agreement, the Commission's review process may result
in an adjustment of the final purchase price, which would be settled in cash,
based on the Commission's determination of plant investment for the systems.
Since the purchase price adjusts by the change in the determined plant
investment or rate base, effectively the rate base adjustment is directly offset
by the change in purchase price. The final purchase price is not expected to
result in the recognition of goodwill.
The acquisition of Heater and the Florida Water Systems were initially
funded by a portion of the proceeds from the issuance by Aqua America of an
unsecured short-term note in May 2004. A portion of the short-term note was
subsequently repaid by Aqua America with the proceeds from a November 2004
secondary equity offering, and a portion of the short-term note was refinanced
through the February 2005 issuance of $30,000 of unsecured notes. In November
2004, we sold 1,955,000 shares of common stock in a public offering for proceeds
of $42,600, net of expenses. In February 2005, Aqua America issued $18,000 of
notes due in 2015 with an interest rate of 5.01% and $12,000 of notes due in
2020 with an interest rate of 5.20%.
12
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)
Pursuant to our growth strategy, on July 31, 2003, we completed the
acquisition of four operating water and wastewater subsidiaries of AquaSource,
Inc., a subsidiary of DQE, Inc., including selected, integrated operating and
maintenance contracts and related assets (individually and collectively the
acquisition is referred to as "AquaSource") for $190,717 in cash, as adjusted
pursuant to the purchase agreement based on working capital at closing. On
August 27, 2004, we were awarded and received $12,289 plus interest in an
arbitration related to the calculation of the final purchase price under the
terms of the purchase agreement, which resulted in a final purchase price of
$178,428. In the consolidated statement of cash flow for 2004, the $12,289 award
has been reported as proceeds on the line titled acquisitions of water and
wastewater systems, net. The acquisition was initially funded by a portion of
the proceeds from the July 2003 issuance of $135,000 of unsecured notes due
2023, with an interest rate of 4.87%, and the issuance of a $90,000 unsecured
note by Aqua America. In August 2003, the $90,000 unsecured note was repaid with
the proceeds from the issuance of 5,000,000 shares of common stock through a
shelf registration. The acquired operations of AquaSource serve over 130,000
water and wastewater customer accounts in 11 states (including the Connecticut
and Kentucky operations which were subsequently sold to other parties). Please
refer to the section captioned "Dispositions" for a discussion of the AquaSource
operations located in Connecticut, Kentucky and New York. The acquisition
provides an expanded platform from which to extend our
growth-through-acquisition strategy of acquiring water and wastewater systems
that are near or adjacent to our existing service territories. The AquaSource
operations are comprised of approximately 600 small systems, which are generally
clustered in regions to achieve some level of operating efficiency.
We continue to hold acquisition discussions with several water and
wastewater systems. Generally acquisitions are expected to be financed through
the issuance of equity (for the acquisition of some investor-owned systems) or
funded initially with short-term debt with subsequent repayment from the
proceeds of long-term debt or proceeds from equity offerings.
Dispositions
In December 2004, as a result of the settlement of a condemnation
action, our Ohio operating subsidiary sold its water utility assets within the
municipal boundaries of the City of Geneva in Ashtabula County, Ohio for net
proceeds of approximately $4,716, which was in excess of the book value for
these assets. The proceeds were used to pay-down short-term debt and the sale
resulted in the recognition in the fourth quarter of 2004 of a gain on the sale
of these assets, net of expenses, of $2,342. The gain is reported in the 2004
consolidated statement of income as a reduction to operations and maintenance
expense. We continue to operate this water system for the City of Geneva under
an operating contract that began upon the closing of the sale for a period
through December 2006. The operating contract provides for an annual base
operating fee of $135 and allows for additional fees to be earned commensurate
with the services provided. These water utility assets represent less than 1% of
Aqua America's total assets, and the total number of customers included in the
water system sold represents less than 1% of our total customer base.
We continue to review and evaluate for possible sale selected areas of
our business and operating divisions that were acquired in July 2003 with the
AquaSource operations. To date, we have completed the following sale
transactions of operating divisions acquired as part of the AquaSource
transaction:
o In July 2004, we sold our only operation in Kentucky. The sale price
approximates our investment in this operation. The operation represented
approximately 0.2% of the operations acquired from AquaSource, Inc.
o In October 2003, we completed the sale of our only operation in
Connecticut. The sale price of $4,000 approximates our investment in this
operation. The operation represented approximately 2% of the operations
acquired from AquaSource, Inc.
In May 2003, we announced an agreement for the sale of the AquaSource
regulated operation located in New York to a New England-based water company. In
January 2005, after the expiration of the sale agreement, we did not renew the
sale agreement. The New York operations represented approximately 1% of the
operations acquired from AquaSource, Inc.
13
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)
In December 2002, as a result of the settlement of a condemnation
action, our Ohio operating subsidiary sold to Ashtabula County, Ohio the water
utility assets in the unincorporated areas of Ashtabula County and the area
within the Village of Geneva on the Lake for net proceeds of $12,118, which was
in excess of the book value for these assets. The proceeds were used to pay down
short-term debt, and the sale resulted in the recognition in the fourth quarter
of 2002 of a gain on the sale of these assets, net of expenses, of $5,676. We
continue to operate this water system for Ashtabula County, beginning after the
closing of the sale, under a multi-year operating contract. The water utility
assets sold represented less than 1% of our total assets, and the total number
of customers included in the water system sold represented less than 1% of our
total customer base.
The City of Fort Wayne, Indiana has authorized the acquisition, by
eminent domain or otherwise, of a portion of the utility assets of one of the
operating subsidiaries that we acquired in connection with the AquaSource
acquisition in 2003. We have challenged whether the City is following the
correct legal procedures in connection with the City's attempted condemnation
and we have challenged the City's valuation of this portion of our system. The
portion of the system under consideration represents approximately 1% of our
total customer base. While we continue to discuss this matter with officials
from the City of Fort Wayne, we continue to protect our interests in this
proceeding. We believe that we will be entitled to fair market value for our
assets if they are condemned, and that the fair market value will be in excess
of the book value for such assets.
Despite these transactions, our strategy continues to be to acquire
additional water and wastewater systems, to maintain our existing systems where
there is a business or a strategic benefit, and to actively oppose unilateral
efforts by municipal governments to acquire any of our operations.
Sources of Capital
Since net operating cash flow plus advances and contributions in aid of
construction have not been sufficient to fully fund cash requirements, we issued
approximately $564,000 of long-term debt and obtained other short-term
borrowings during the past five years. At December 31, 2004, we had short-term
lines of credit and other credit facilities of $198,000, of which $159,190 was
available. Our short-term lines of credit and other credit facilities are either
payable on demand or have a 364-day term.
In April 2003, we filed a universal shelf registration with the SEC to
allow for the sale, over time, of up to $250,000 of various debt and equity
securities, including common stock. To date, we have completed three issuances
under the universal shelf registration:
o In November 2004, we sold 1,955,000 shares of common stock in a public
offering for proceeds of $42,600, net of expenses. The net proceeds were
used to repay a portion of our short-term debt. The short-term debt was
incurred by Aqua America in connection with the Heater and Florida Water
acquisitions.
o In August 2003, we sold 5,000,000 shares of common stock in a public
offering for proceeds of $90,100, net of expenses. The net proceeds were
used to repay an unsecured note of $90,000. The indebtedness was incurred
by Aqua America in connection with the acquisition of the operations that
were purchased from AquaSource, Inc.
o In May 2003, we sold 1,868,750 shares of common stock in a public offering
for proceeds of $33,100, net of expenses. The net proceeds were used to
repay short-term debt, including the repayment of $22,000 of indebtedness
incurred in connection with our repurchase of 1,513,275 shares of our
common stock from affiliates of Veolia Environnement, S.A., formerly
Vivendi Enivironnement, S.A., in October 2002.
14
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)
The balance remaining available for use under the universal shelf
registration as of December 31, 2004 is $77,517. In addition, we have a shelf
registration statement filed with the SEC to permit the offering from time to
time of shares of common stock and shares of preferred stock for acquisitions.
During 2004 and 2003, no shares were issued from the acquisition shelf
registration. During 2002, 178,664 shares of common stock totaling $2,745, were
issued to acquire water and wastewater systems. The balance remaining available
for use under the acquisition shelf registration as of December 31, 2004 is
2,218,947 shares. The form and terms of such securities shall be determined when
and if these securities are issued under these shelf registrations.
In September 2000, we sold 2,583,008 shares of common stock in a public
offering for net proceeds of $29,689. The proceeds of this offering were used to
make an equity contribution to our Pennsylvania operating subsidiary.
We offer a Dividend Reinvestment and Direct Stock Purchase Plan (Plan)
that provides a convenient and economical way to purchase shares of Aqua
America, Inc. Under the direct stock purchase portion of the Plan, shares are
sold throughout the year. The dividend reinvestment portion of the Plan offers a
5% discount on the purchase of shares of common stock with reinvested dividends.
As of the December 2004 dividend payment, holders of 16.9% of the common shares
outstanding participated in the dividend reinvestment portion of the Plan. The
shares issued under the Plan are either original issue shares or shares
purchased by the Company's transfer agent in the open-market. During the past
five years, we have sold 2,086,736 original issue shares of common stock for net
proceeds of $32,677 through the dividend reinvestment portion of the Plan and
the proceeds were used to invest in our operating subsidiaries, to repay
short-term debt, and for general corporate purposes.
Other Capital Transactions
In May 2002, Veolia Environnement, S.A., formerly Vivendi Environnement,
S.A., which through its affiliates (collectively "VE") owned approximately 16.8%
of our outstanding common stock, advised us of its decision to sell its
investment in Aqua America. VE announced that its decision was part of its
overall strategy to divest non-core assets and focus on other business
strategies. In September 2002, in order to facilitate the orderly
re-distribution of the shares held by VE into the market, we completed a
secondary offering of 12,356,570 shares of Aqua America common stock held by VE.
The number of outstanding shares of common stock was not changed and we did not
receive any proceeds as a result of this secondary offering. In addition, in
October 2002 we repurchased 1,513,275 shares of Aqua America common stock
representing the remainder of the shares of Aqua America common stock held by
VE. The repurchase of shares was funded with proceeds of $22,000 from a
short-term credit facility. In May 2003, this $22,000 short-term credit facility
was repaid with funds from the issuance of 1,868,750 shares of common stock
through a shelf registration, providing proceeds of approximately $33,100, net
of expenses. The balance of the net proceeds were used to repay other short-term
debt.
The Board of Directors has authorized us to purchase our common stock,
from time to time, in the open market or through privately negotiated
transactions. We have not purchased any shares under this authorization since
2000. As of December 31, 2004, 411,209 shares remain available for repurchase.
Funding for future stock purchases, if any, is not expected to have a material
impact on our financial position.
15
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)
Contractual Obligations
The following table summarizes our contractual cash obligations as of
December 31, 2004:
Payments Due By Period
- ------------------------------------------------------------------------------------------------------------------
2005 2006 2007 2008 2009 Thereafter Total
- ------------------------------------------------------------------------------------------------------------------
Long-term debt (a) $ 50,195 $ 24,623 $ 31,068 $ 23,756 $ 6,816 $ 698,198 $ 834,656
Operating leases (b) 2,926 2,309 1,669 1,336 969 15,907 25,116
Unconditional purchase
obligations (c) 10,840 10,760 11,325 11,103 10,594 82,388 137,010
Other purchase
obligations (d) 6,244 - - - - - 6,244
Postretirement benefit
plans' obligations (e) 10,082 - - - - - 10,082
Other obligations (f) 3,352 400 400 267 130 - 4,549
-----------------------------------------------------------------------------------------
Total $ 83,639 $ 38,092 $ 44,462 $ 36,462 $ 18,509 $ 796,493 $ 1,017,657
=========================================================================================
(a) Represents sinking fund obligations and debt maturities.
(b) Represents operating leases that are noncancelable, before expiration, for
the lease of motor vehicles, buildings, land and other equipment.
(c) Represents our commitment to purchase minimum quantities of water as
stipulated in agreements with other water purveyors. We use purchased water
to supplement our water supply, particularly during periods of peak customer
demand.
(d) Represents an approximation of the open purchase orders as of the period end
for goods and services purchased in the ordinary course of business.
(e) Represents contributions expected to be made to postretirement benefit
plans. The amount of required contributions in 2006 and thereafter is not
determinable.
(f) Represents capital expenditures estimated to be required under legal and
binding contractual obligations.
In addition to these obligations, we make refunds on Customers'
Advances for Construction over a specific period of time based on operating
revenues related to developer-installed water mains or as new customers are
connected to and take service from such mains. After all refunds are made, any
remaining balance is transferred to Contributions in Aid of Construction. The
refund amounts are not included in the above table because the refund amounts
and timing 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 refund amounts are payable
annually through 2017 and amounts not paid by the contract expiration dates
become non-refundable.
These contractual obligations will be funded from cash flows from
operations and liquidity sources held by or available to Aqua America.
Market Risk
We are subject to market risks in the normal course of business,
including changes in interest rates and equity prices. The exposure to changes
in interest rates is a result of financings through the issuance of fixed-rate,
long-term debt. Such exposure is typically related to financings between utility
rate increases, because generally our rate increases provide a revenue level to
allow recovery of our current cost of capital.
16
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)
Interest rate risk is managed through the use of a combination of long-term
debt, which is at fixed interest rates and short-term debt, which is at floating
interest rates. As of December 31, 2004, the debt maturities by period and the
weighted average interest rate for fixed-rate, long-term debt are as follows:
Fair
2005 2006 2007 2008 2009 Thereafter Total Value
- ---------------------------------------------------------------------------------------------------------------
Long-term
debt (fixed rate) $ 50,195 $ 24,623 $ 31,068 $ 23,756 $ 6,816 $ 698,198 $ 834,656 $ 863,247
Weighted average
interest rate 7.19% 5.69% 5.10% 6.66% 4.89% 5.93% 6.00%
From time to time, we make investments in marketable equity securities.
As a result, we are exposed to the risk of changes in equity prices for the
"available for sale" marketable equity securities. As of December 31, 2004, we
owned no marketable equity securities as we sold the balance of our securities
during 2004. As a result, the market risks to which we are exposed are less than
the risks to which we were exposed in the prior year.
Capitalization
The following table summarizes our capitalization during the past five
years:
December 31, 2004 2003 2002 2001 2000
- ---------------------------------------------------------------------------------------------------
Long-term debt* 52.8% 52.8% 55.6% 52.9% 52.4%
Preferred stock 0.0% 0.0% 0.0% 0.1% 0.2%
Common stockholders' equity 47.2% 47.2% 44.4% 47.0% 47.4%
- ---------------------------------------------------------------------------------------------------
100.0% 100.0% 100.0% 100.0% 100.0%
===================================================================================================
*Includes current portion.
The changes in the capitalization ratios primarily result from the
issuance of common stock over the past five years, and the issuance of debt to
finance our acquisitions and capital program and the previously mentioned
repurchase of common stock from Veolia Environnement (formerly Vivendi, S.A.) in
2002. It is our goal to maintain an equity ratio adequate to support our current
Standard and Poors corporate credit rating of "A+" and its senior secured debt
rating of "AA-" for Aqua Pennsylvania, our largest operating subsidiary.
Dividends on Common Stock
We have paid common dividends consecutively for 60 years. Effective
December 1, 2004, our Board of Directors authorized an increase of 8.3% in the
dividend rate over the amount we paid in the previous quarter. As a result of
this authorization, beginning with the dividend payment in December 2004, the
annual dividend rate increased to $0.52 per share. We presently intend to pay
quarterly cash dividends in the future, on March 1, June 1, September 1 and
December 1, subject to our earnings and financial condition, regulatory
requirements and such other factors as our Board of Directors may deem relevant.
During the past five years, our common dividends paid have averaged 56.6% of net
income.
17
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)
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our financial condition and results of operations are impacted by the
methods, assumptions, and estimates used in the application of critical
accounting policies. The following accounting policies are particularly
important to our financial condition or results of operations, and require
estimates or other judgements of matters of uncertainty. Changes in the
estimates or other judgements included within these accounting policies could
result in a significant change to the financial statements. We believe our most
critical accounting policies include revenue recognition, the use of regulatory
assets and liabilities as permitted by Statement of Financial Accounting
Standards ("SFAS") No. 71, "Accounting for the Effects of Certain Types of
Regulation," the review for impairment of our long-lived assets which consist
primarily of Utility Plant in Service and regulatory assets, and our accounting
for pensions and other postretirement benefits.
Revenue Recognition - Our utility revenues recognized in an accounting period
include amounts billed to customers on a cycle basis and unbilled amounts based
on estimated usage from the last billing to the end of the accounting period.
The estimated usage is based on our judgement and assumptions; our actual
results could differ from these estimates which would result in operating
revenues being adjusted in the period that the revision to our estimates are
determined.
Regulatory Assets and Liabilities - SFAS No. 71 stipulates generally accepted
accounting principles for companies whose rates are established by or are
subject to approval by an independent third-party regulator. In accordance with
SFAS No. 71, we defer costs and credits on the balance sheet as regulatory
assets and liabilities when it is probable that these costs and credits will be
recognized in the rate-making process in a period different from when the costs
and credits were incurred. These deferred amounts, both assets and liabilities,
are then recognized in the income statement in the same period that they are
reflected in our rates charged for water and wastewater service. In the event
that our assessment as to the probability of the inclusion in the rate-making
process is incorrect, the associated regulatory asset or liability would be
adjusted to reflect the change in our assessment or change in regulatory
approval.
Impairment of Long-Lived Assets - In accordance with the requirements of SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", we
review for impairment of our long-lived assets, including Utility Plant in
Service. We also review regulatory assets for the continued application of SFAS
No. 71. Our review determines whether there have been changes in circumstances
or events that have occurred that require adjustments to the carrying value of
these assets. In accordance with SFAS No. 71, adjustments to the carrying value
of these assets would be made in instances where the inclusion in the
rate-making process is unlikely.
Accounting for Postretirement Benefits - We maintain a qualified defined benefit
pension plan and plans that provide for certain postretirement benefits other
than pensions. Accounting for pensions and other postretirement benefits
requires an extensive use of assumptions about the discount rate, expected
return on plan assets, the rate of future compensation increases received by our
employees, mortality, turnover and medical costs. Each assumption is reviewed
annually with assistance from our actuarial consultant who provides guidance in
establishing the assumptions. 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 we recognize.
Our discount rate is based on a market rate for a recognized-rating
agency's high-quality long-term bond portfolio with durations matching the
expected payouts under our retirement plans. Our pension expense and liability
(benefit obligations) increases as the discount rate is reduced. A 25
basis-point reduction in this assumption would have increased 2004 pension
expense by $550 and the pension liabilities by $6,500. The present values of
Aqua America's future pension and other postretirement obligations were
determined using discount rates of 5.75% at December 31, 2004 and 6.25% at
December 31, 2003. Our expense under these plans is determined using the
discount rate as of the beginning of the year, which was 6.25% for 2004, and
will be 5.75% for 2005.
18
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)
Our expected return on assets is determined by evaluating the asset
class return expectations with our advisors as well as actual, long-term,
historical results of our asset returns. Our pension expense increases as the
expected return on assets decreases. A 25 basis-point reduction in this
assumption would have increased 2004 pension expense by $270. For 2004, we used
an 8.5% expected return on assets assumption which will remain unchanged for
2005. The expected return on assets is based on a targeted allocation of 65%
equities and 35% fixed income. We believe that our actual long-term asset
allocation on average will approximate the targeted allocation. Our targeted
allocation is driven by the investment strategy to earn a reasonable rate of
return while maintaining risk at acceptable levels through the diversification
of investments across and with various asset categories.
As of December 31, 2004, we have an additional minimum liability of
$6,820 associated with our defined benefit pension plans. The additional minimum
liability is a result of the accumulated benefit obligation exceeding the fair
value of plan assets. The portion of the additional minimum liability related to
our employees in one of our rate jurisdictions results in the establishment of a
regulatory asset of $4,140, as we expect recovery of the future, increased
pension expense through customer rates. Since the balance of the additional
minimum liability of $2,680 may not be recovered through rates, the accounting
requirements for recording a regulatory asset are not met and as a result this
amount is recorded as an other comprehensive loss for 2004 through a charge to
accumulated other comprehensive income, net of income tax benefits of $938. The
change in the additional minimum liability from December 31, 2003 of $41 to
December 31, 2004 of $6,820 resulted from the effect of a decreased discount
rate, offset partially by an increase in the pension plan assets during 2004 due
to positive equity market performance and pension contributions. Although
additional minimum liability does not directly impact net income or cash flow,
in future years, our pension expense and cash funding requirements are
anticipated to increase as a result of the decline in the plans' funded status.
Funding requirements for qualified defined benefit pension plans are determined
by government regulations and not by accounting pronouncements. In accordance
with our funding policy, during 2005 our required pension contribution is
expected to be approximately $7,278. We expect future changes in the amount of
contributions and expense recognized will be generally included in customer
rates.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In May 2004, the Financial Accounting Standards Board ("FASB") issued
FASB Staff Position ("FSP") No. 106-2, "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003." FSP 106-2 supersedes FSP 106-1, "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003," which was issued in January 2004 and permitted a sponsor of a
postretirement health care plan that provides a prescription drug benefit to
make a one-time election to defer accounting for the effects of the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") until
more authoritative guidance on the accounting for the federal subsidy was
issued. We had elected the one-time deferral allowed under FSP 106-1 and as a
result we adopted FSP 106-2 as required in the third quarter of 2004 and it did
not have a material impact on our results of operation or financial position.
In November 2004, the FASB approved Statement of Financial Accounting
Standards ("SFAS") No. 151, "Inventory Costs - An Amendment of ARB No. 43,
Chapter 4." SFAS No. 151 requires the exclusion of certain costs from
inventories and the allocation of fixed production overheads to inventories to
be based on the normal capacity of the production facilities. The standard is
effective for Aqua America for costs incurred after December 31, 2005. We
believe this statement will not have a material impact on our results of
operations or financial position.
19
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)
In November 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets - An Amendment of APB Opinion No. 29." SFAS No. 153
eliminates the exception for nonmonetary exchanges of similar productive assets
and replaces it with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. SFAS No. 153 specifies that a nonmonetary
exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. SFAS No. 153 is
effective for fiscal periods beginning after June 15, 2005. We believe this
statement will not have a material impact on our results of operations or
financial position.
On October 22, 2004, the American Jobs Creation Act ("AJCA") was signed
into law. Among other provisions, the AJCA creates a new deduction for qualified
domestic production activities. Certain of our activities, such as our water
treatment activity, are considered as qualifying production activities for
purposes of determining the deduction for qualified production activities. In
December 2004, the FASB issued FSP 109-1, "Application of FASB Statement No.
109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004." In accordance
with FSP 109-1, we will treat the deduction for qualified domestic production
activities as a reduction of the income tax provision in future years as
realized. The AJCA and FSP 109-1 did not impact our 2004 consolidated financial
statements. We are currently assessing the impact, if any, of the AJCA and FSP
109-1 on our consolidated financial statements in future periods. We believe the
deduction could impact our future effective income tax rate and it is not
expected to have a material impact on our results of operations or financial
position.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment,"
which is effective for reporting periods beginning after June 15, 2005 (our
third quarter 2005 period). This standard revises SFAS No. 123, "Accounting for
Stock-based Compensation," and supersedes APB No. 25, "Accounting for Stock
Issued to Employees." As noted in the footnotes to our consolidated financial
statements, we currently provide pro forma disclosure of compensation costs
associated with the fair value of stock options that have been granted. We
currently account for stock-based compensation associated with stock options
using the intrinsic method, and accordingly, no compensation costs have been
recognized in our consolidated financial statements. SFAS 123R generally
requires that we measure the cost of employee services received in exchange for
stock-based awards on the grant-date fair value and this cost will be recognized
over the period during which an employee provides service in exchange for the
award. The fair value of the option grant will be estimated using an
option-pricing model. We are currently evaluating this standard to determine the
impact on our consolidated financial statements, including the selection of an
appropriate option-pricing model as permitted under SFAS No. 123R, and the
method by which we will adopt SFAS No. 123R. We are currently evaluating the
requirements of SFAS No. 123R and we expect the adoption of this standard will
have a material impact on our results of operations and earnings per share.
20
AQUA AMERICA, INC. AND SUBSIDIARIES
Management's Report On Internal Control Over Financial Reporting
Management of Aqua America, Inc. (the "Company") is responsible for
establishing and maintaining adequate internal control over financial reporting.
Internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the Company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are
being made only in accordance with authorizations of management and directors of
the Company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the Company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In assessing the effectiveness of internal control over financial
reporting, management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control-Integrated
Framework. As a result of management's assessment and based on the criteria in
the framework, management has concluded that, as of December 31, 2004, the
Company's internal control over financial reporting was effective.
Management evaluated the Company's internal control over financial
reporting as of December 31, 2004. In conducting this assessment, management has
excluded Heater Utilities, Inc. from its assessment because it was acquired by
the Company in a purchase business combination during 2004. Heater Utilities,
Inc., is a wholly-owned subsidiary, whose total assets and total revenues
represent approximately 5% and 3%, respectively, of the related consolidated
financial statement amounts as of and for the year ended December 31, 2004.
The Company's independent registered public accounting firm,
PricewaterhouseCoopers LLP, has audited management's assessment of the
effectiveness of the Company's internal control over financial reporting, as
stated in their report which appears herein.
NICHOLAS DEBENEDICTIS DAVID P. SMELTZER
Nicholas DeBenedictis David P. Smeltzer
Chairman & Senior Vice President - Finance
President
March 14, 2005
21
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
Aqua America, Inc.:
We have completed an integrated audit of Aqua America, Inc.'s 2004 consolidated
financial statements and of its internal control over financial reporting as of
December 31, 2004 and audits of its 2003 and 2002 financial statements in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income and comprehensive income, of capitalization
and of cash flows present fairly, in all material respects, the financial
position of Aqua America, Inc. and its subsidiaries at December 31, 2004 and
2003, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2004 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit of financial statements includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, management's assessment, included in Management's Report
on Internal Control Over Financial Reporting, appearing in the 2004 Annual
Report to Shareholders, that the Company maintained effective internal control
over financial reporting as of December 31, 2004 based on criteria established
in Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), is fairly stated, in all
material respects, based on those criteria. Furthermore, in our opinion, the
Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2004, based on criteria established in
Internal Control - Integrated Framework issued by the COSO. The Company's
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express opinions on
management's assessment and on the effectiveness of the Company's internal
control over financial reporting based on our audit. We conducted our audit of
internal control over financial reporting in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether effective internal control over financial reporting was maintained in
all material respects. An audit of internal control over financial reporting
includes obtaining an understanding of internal control over financial
reporting, evaluating management's assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
22
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
As described in Management's Report on Internal Control Over Financial
Reporting, management has excluded Heater Utilities, Inc. from its assessment of
internal control over financial reporting as of December 31, 2004 because it was
acquired by the Company in a purchase business combination during 2004. We have
also excluded Heater Utilities, Inc. from our audit of internal control over
financial reporting. Heater Utilities, Inc., is a wholly-owned subsidiary, whose
total assets and total revenues represent approximately 5% and 3%, respectively,
of the related consolidated financial statement amounts as of and for the year
ended December 31, 2004.
PRICEWATERHOUSECOOPERS LLP
PricewaterhouseCoopers LLP
Philadelphia, PA
March 14, 2005
23
AQUA AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(In thousands, except per share amounts)
Years ended December 31, 2004, 2003 and 2002
2004 2003 2002
----------------------------------------
Operating revenues $ 442,039 $ 367,233 $ 322,028
Costs and expenses:
Operations and maintenance 178,345 140,602 117,735
Depreciation 54,564 48,522 41,424
Amortization 4,300 2,941 2,898
Taxes other than income taxes 27,596 21,607 19,467
----------------------------------------
264,805 213,672 181,524
Operating income 177,234 153,561 140,504
Other expense (income):
Interest expense, net 48,679 44,662 40,396
Allowance for funds used during construction (2,304) (2,127) (1,389)
Gain on sale of water system - - (5,676)
Gain on sale of other assets (1,272) (5,692) (2,079)
----------------------------------------
Income before income taxes 132,131 116,718 109,252
Provision for income taxes 52,124 45,923 42,046
----------------------------------------
Net income 80,007 70,795 67,206
Dividends on preferred stock - 10 52
----------------------------------------
Net income available to common stock $ 80,007 $ 70,785 $ 67,154
========================================
Net income $ 80,007 $ 70,795 $ 67,206
Other comprehensive income (loss), net of tax:
Minimum pension liability adjustment (1,742) - -
Unrealized gains on securities 59 455 104
Reclassification adjustment for gains reported in net income (230) (347) (767)
----------------------------------------
(1,913) 108 (663)
----------------------------------------
Comprehensive income $ 78,094 $ 70,903 $ 66,543
========================================
Net income per common share:
Basic $ 0.86 $ 0.80 $ 0.78
========================================
Diluted $ 0.85 $ 0.79 $ 0.78
========================================
Average common shares outstanding during the period:
Basic 93,247 88,275 85,674
========================================
Diluted 94,282 89,244 86,538
========================================
See accompanying notes to consolidated financial statements.
24
AQUA AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands of dollars, except per share amounts)
December 31, 2004 and 2003
2004 2003
--------------------------
Assets
Property, plant and equipment, at cost $ 2,626,151 $ 2,302,304
Less accumulated depreciation 556,339 478,013
--------------------------
Net property, plant and equipment 2,069,812 1,824,291
--------------------------
Current assets:
Cash and cash equivalents 13,116 10,757
Accounts receivable and unbilled revenues, net 64,538 62,320
Inventory, materials and supplies 6,903 5,841
Prepayments and other current assets 5,570 5,051
--------------------------
Total current assets 90,127 83,969
--------------------------
Regulatory assets 110,993 98,761
Deferred charges and other assets, net 31,998 34,277
Funds restricted for construction activity 17,196 28,438
Goodwill 20,122 -
--------------------------
$ 2,340,248 $ 2,069,736
==========================
Liabilities and Stockholders' Equity
Stockholders' equity:
Common stock at $.50 par value, authorized 300,000,000 shares,
issued 96,071,580 and 93,270,424 in 2004 and 2003 $ 48,036 $ 46,635
Capital in excess of par value 468,524 413,008
Retained earnings 245,115 210,915
Minority interest 1,237 912
Treasury stock, at cost, 686,747 and 681,384 shares in 2004 and 2003 (12,702) (12,611)
Accumulated other comprehensive income (1,742) 171
--------------------------
Total stockholders' equity 748,468 659,030
--------------------------
Long-term debt, excluding current portion 784,461 696,666
Commitments - -
Current liabilities:
Current portion of long-term debt 50,195 39,386
Loans payable 85,115 96,459
Accounts payable 23,534 32,321
Accrued interest 12,029 11,126
Accrued taxes 8,975 16,779
Other accrued liabilities 37,534 35,930
--------------------------
Total current liabilities 217,382 232,001
--------------------------
Deferred credits and other liabilities:
Deferred income taxes and investment tax credits 223,887 190,395
Customers' advances for construction 73,095 72,500
Other 15,147 9,419
--------------------------
Total deferred credits and other liabilities 312,129 272,314
--------------------------
Contributions in aid of construction 277,808 209,725
--------------------------
$ 2,340,248 $ 2,069,736
===========================
See accompanying notes to consolidated financial statements.
25
AQUA AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CAPITALIZATION
(In thousands of dollars, except per share amounts)
December 31, 2004 and 2003
2004 2003
--------------------------
Stockholders' equity:
Common stock, $.50 par value $ 48,036 $ 46,635
Capital in excess of par value 468,524 413,008
Retained earnings 245,115 210,916
Minority interest 1,237 912
Treasury stock, at cost (12,702) (12,612)
Accumulated other comprehensive income (1,742) 171
--------------------------
Total stockholders' equity 748,468 659,030
--------------------------
Long-term debt:
Long-term debt of subsidiaries (substantially secured by utility plant):
Interest Rate Range
0.00% to 2.49% 20,051 16,868
2.50% to 2.99% 29,924 18,913
3.00% to 3.49% 17,546 5,618
3.50% to 3.99% 7,123 2,800
4.00% to 4.99% 9,435 8,135
5.00% to 5.49% 165,615 110,875
5.50% to 5.99% 89,260 76,260
6.00% to 6.49% 110,360 119,360
6.50% to 6.99% 42,000 42,000
7.00% to 7.49% 45,105 46,716
7.50% to 7.99% 25,231 23,000
8.00% to 8.49% 26,714 17,500
8.50% to 8.99% 9,000 9,000
9.00% to 9.49% 53,244 53,805
9.50% to 9.99% 42,088 43,242
10.00% to 10.50% 6,000 6,000
--------------------------
698,696 600,092
Note payable, 6.05%, due 2006 960 960
Unsecured notes payable, 4.87%, due 2023 135,000 135,000
--------------------------
834,656 736,052
Current portion of long-term debt 50,195 39,386
--------------------------
Long-term debt, excluding current portion 784,461 696,666
--------------------------
Total capitalization $ 1,532,929 $ 1,355,696
==========================
See accompanying notes to consolidated financial statements.
26
AQUA AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
(In thousands of dollars, except per share amounts)
Accumulated
Capital in Other
Common excess of Retained Treasury Comprehensive
Stock par value earnings Stock Income Total
-------------------------------------------------------------------------
Balance at December 31, 2001 $ 34,650 $ 304,039 $ 149,682 $ (17,167) $ 726 $ 471,930
Net income - - 67,154 - - 67,154
Other comprehensive income: unrealized
gains on securities, net of income tax of $56 - - - - 104 104
Reclassification adjustment for gains reported
in net income, net of income tax of $412 - - - - (767) (767)
Dividends - - (36,789) - - (36,789)
Stock issued for acquisitions (178,864 shares) 71 2,674 - - - 2,745
Sale of stock (448,593 shares) 161 6,220 - 855 - 7,236
Repurchase of stock (1,274,680 shares) - - - (24,109) - (24,109)
Equity Compensation Plan (37,031 shares) 15 598 - - - 613
Exercise of stock options (339,178 shares) 137 3,237 - - - 3,374
Employee stock plan tax benefits - 1,103 - - - 1,103
-------------------------------------------------------------------------
Balance at December 31, 2002 35,034 317,871 180,047 (40,421) 63 492,594
-------------------------------------------------------------------------
Net income - - 70,785 - - 70,785
Other comprehensive income: unrealized
gains on securities, net of income tax of $244 - - - - 455 455
Reclassification adjustment for gains reported
in net income, net of income tax of $186 - - - - (347) (347)
Dividends - - (39,917) - - (39,917)
Stock split 9,244 (9,244) - - - -
Sale of stock (7,308,870 shares) 2,168 99,031 - 29,163 - 130,362
Repurchase of stock (60,646 shares) - - - (1,353) - (1,353)
Equity Compensation Plan (20,156 shares) 8 344 - - - 352
Exercise of stock options (434,833 shares) 181 4,283 - - - 4,464
Employee stock plan tax benefits - 723 - - - 723
-------------------------------------------------------------------------
Balance at December 31, 2003 46,635 413,008 210,915 (12,611) 171 658,118
-------------------------------------------------------------------------
Net income - - 80,007 - - 80,007
Other comprehensive income (loss):
Minimum pension liability adjustment,
net of income tax of $938 - - - - (1,742) (1,742)
Unrealized gain on securities, net of
income tax of $32 - - - - 59 59
Less: Reclassification adjustment for
gains reported in net income, net of
income tax of $173 - - - - (230) (230)
Dividends - - (45,807) - - (45,807)
Sale of stock (2,385,902 shares) 1,170 48,971 - 991 - 51,132
Repurchase of stock (51,808 shares) - - - (1,082) - (1,082)
Equity Compensation Plan (34,151 shares) 17 692 - - - 709
Exercise of stock options (427,548 shares) 214 4,847 - - - 5,061
Employee stock plan tax benefits - 1,006 - - - 1,006
-------------------------------------------------------------------------
Balance at December 31, 2004 $ 48,036 $ 468,524 $ 245,115 $ (12,702) $ (1,742) $ 747,231
=========================================================================
See accompanying notes to consolidated financial statements.
27
AQUA AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED CASH FLOW STATEMENTS
(In thousands of dollars)
Years ended December 31, 2004, 2003 and 2002
2004 2003 2002
----------------------------------------
Cash flows from operating activities:
Net income $ 80,007 $ 70,795 $ 67,206
Adjustments to reconcile net income to net cash
flows from operating activities:
Depreciation and amortization 58,864 51,463 44,322
Deferred income taxes 40,577 26,741 18,470
Gain on sale of water system (2,342) - (5,676)
Gain on sale of other assets (1,272) (5,692) (2,079)
Net increase in receivables, inventory and prepayments (2,766) (314) (742)
Net increase in payables, accrued interest, accrued taxes
and other accrued liabilities 863 7,777 1,346
Other (328) (7,397) (1,287)
----------------------------------------
Net cash flows from operating activities 173,603 143,373 121,560
----------------------------------------
Cash flows from investing activities:
Property, plant and equipment additions, including allowance for
funds used during construction of $2,304, $2,127 and $1,389 (195,736) (163,320) (136,164)
Acquisitions of water and wastewater systems, net (54,300) (192,331) (8,914)
Net decrease (increase) in funds restricted for construction activity 11,243 15,314 (23,986)
Net proceeds from the sale of water systems 4,716 4,000 12,118
Net proceeds from the sale of other assets 2,098 6,496 6,258
Other (517) (312) (362)
----------------------------------------
Net cash flows used in investing activities (232,496) (330,153) (151,050)
----------------------------------------
Cash flows from financing activities:
Customers' advances and contributions in aid of construction 14,269 8,181 10,266
Repayments of customers' advances (4,930) (4,257) (5,070)
Net proceeds (repayments) of short-term debt (31,900) (18,654) 5,445
Proceeds from long-term debt 130,258 154,537 119,350
Repayments of long-term debt (55,928) (44,204) (43,279)
Redemption of preferred stock - (172) (944)
Proceeds from issuing common stock 56,193 134,826 10,611
Repurchase of common stock (1,082) (1,353) (24,109)
Dividends paid on preferred stock - (10) (52)
Dividends paid on common stock (45,807) (39,917) (36,789)
Other 179 2,645 (1,034)
----------------------------------------
Net cash flows from financing activities 61,252 191,622 34,395
----------------------------------------
Net increase in cash and cash equivalents 2,359 4,842 4,905
Cash and cash equivalents at beginning of year 10,757 5,915 1,010
----------------------------------------
Cash and cash equivalents at end of year $ 13,116 $ 10,757 $ 5,915
========================================
Cash paid during the year for:
Interest, net of amounts capitalized $ 45,261 $ 40,572 $ 38,040
========================================
Income taxes $ 22,322 $ 19,168 $ 24,165
========================================
See Summary of Significant Accounting Policies-Customers' Advances for
Construction, Acquisitions and Employee Stock and Incentive Plans footnotes
for description of non-cash activities.
See accompanying notes to consolidated financial statements.
28
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
Summary of Significant Accounting Policies
Name Change - On January 16, 2004, Philadelphia Suburban Corporation changed its
corporate name to Aqua America, Inc. In addition, we changed our ticker symbol
from PSC to WTR on the New York Stock Exchange and Philadelphia Stock Exchange
effective on January 20, 2004.
Nature of Operations - Aqua America, Inc. ("Aqua America" or the "Company") is
the holding company for regulated utilities providing water or wastewater
services in Pennsylvania, Ohio, North Carolina, Illinois, Texas, New Jersey,
Florida, Indiana, Virginia, Maine, Missouri, New York and South Carolina. Our
largest operating subsidiary, Aqua Pennsylvania, Inc. - formerly Pennsylvania
Suburban Water Company, accounts for approximately 57% of our operating revenues
and provides water or wastewater service to customers in the suburban areas
north and west of the City of Philadelphia and in 21 other counties in
Pennsylvania. The Company's other subsidiaries provide similar services in 12
other states. In addition, the Company provides water and wastewater service
through operating and maintenance contracts with municipal authorities and other
parties close to our operating companies' service territories.
Regulation - Most of the operating companies that are regulated public utilities
are subject to regulation by the public utility commissions of the states in
which they operate. The respective public utility commissions have jurisdiction
with respect to rates, service, accounting procedures, issuance of securities,
acquisitions and other matters. Some of the operating companies that are
regulated public utilities are subject to rate regulation by county or city
government. Regulated public utilities follow Statement of Financial Accounting
Standards ("SFAS") No. 71, "Accounting for the Effects of Certain Types of
Regulation." SFAS No. 71 provides for the recognition of regulatory assets and
liabilities as allowed by regulators for costs or credits that are reflected in
current rates or are considered probable of being included in future rates. The
regulatory assets or liabilities are then relieved as the cost or credit is
reflected in rates.
Consolidation - The consolidated financial statements include the accounts of
the Company and its subsidiaries. All material intercompany accounts and
transactions have been eliminated where appropriate.
Recognition of Revenues - Revenues include amounts billed to customers on a
cycle basis and unbilled amounts based on estimated usage from the
latest billing to the end of the accounting period. Nonregulated revenues are
recognized when services are performed and are primarily associated with
operating and maintenance contracts and data processing service fees.
Nonregulated revenues totaled $13,623 in 2004, $11,806 in 2003 and $7,190 in
2002.
Property, Plant and Equipment and Depreciation - Property, plant and equipment
consist primarily of utility plant. The cost of additions includes contracted
cost, direct labor and fringe benefits, materials, overheads and, for certain
utility plant, allowance for funds used during construction. Water systems
acquired are recorded at estimated original cost of utility plant when first
devoted to utility service and the applicable depreciation is recorded to
accumulated depreciation. The difference between the estimated original cost,
less applicable accumulated depreciation, and the purchase price is recorded as
an acquisition adjustment within utility plant. At December 31, 2004, utility
plant includes a net credit acquisition adjustment of $63,347, which is
generally being amortized from 0 to 20 years. Amortization of the acquisition
adjustments totaled $3,961 in 2004, $1,649 in 2003 and $633 during 2002.
Utility expenditures for maintenance and repairs, including major
maintenance projects and minor renewals and betterments, are charged to
operating expenses when incurred in accordance with the system of accounts
prescribed by the public utility commissions of the states in which the company
operates. The cost of new units of property and betterments are capitalized.
29
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
When units of utility property are replaced, retired or abandoned, the
recorded value thereof is credited to the asset account and such value, together
with the net cost of removal, is charged to accumulated depreciation. To the
extent the Company recovers cost of removal or other retirement costs through
rates after the retirement costs are incurred, a regulatory asset is recorded.
In some cases, the Company recovers retirement costs through rates during the
life of the associated asset and before the costs are incurred. These amounts
result in a regulatory liability being reported based on the amounts previously
recovered through customer rates.
The straight-line remaining life method is used to compute depreciation
on utility plant. Generally, the straight-line method is used with respect to
transportation and mechanical equipment, office equipment and laboratory
equipment.
In accordance with the requirements of Statement of Financial
Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", the long-lived assets of the Company, which
consist primarily of Utility Plant in Service and regulatory assets, are
reviewed for impairment when changes in circumstances or events occur. There has
been no change in circumstances or events that have occurred that require
adjustments to the carrying values of these assets.
Allowance for Funds Used During Construction - The allowance for funds used
during construction ("AFUDC") is a non-cash credit which represents the
estimated cost of funds used to finance the construction of utility plant. In
general, AFUDC is applied to construction projects requiring more than one month
to complete. No AFUDC is applied to projects funded by customer advances for
construction or contributions in aid of construction. AFUDC includes the net
cost of borrowed funds and a rate of return on other funds when used, and is
recovered through water rates as the utility plant is depreciated. The amount of
AFUDC related to equity funds in 2002 was $9. There was no AFUDC related to
equity funds in 2004 and 2003. No interest was capitalized by our nonregulated
businesses.
Cash and Cash Equivalents - The Company considers all highly liquid investments
with an original maturity of three months or less, which are not restricted for
construction activity, to be cash equivalents.
Accounts Receivable - Accounts receivable are recorded at the invoiced amounts.
The allowance for doubtful accounts is the Company's best estimate of the amount
of probable credit losses in our existing accounts receivable, and is determined
based on historical write-off experience. The Company reviews the allowance for
doubtful accounts quarterly. Account balances are written off against the
allowance when it is probable the receivable will not be recovered.
Deferred Charges and Other Assets - Deferred charges and other assets consist of
financing expenses, other costs and marketable securities. Deferred bond
issuance expenses are amortized by the straight-line method over the life of the
related issues. Call premiums related to the early redemption of long-term debt,
along with the unamortized balance of the related issuance
expense, are deferred and amortized over the life of the long-term debt used to
fund the redemption. Other costs, for which the Company has received or expects
to receive prospective rate recovery, are deferred and amortized over the period
of rate recovery in accordance with SFAS No. 71.
Marketable securities are considered "available-for-sale" and
accordingly, are carried on the balance sheet at fair market value. Unrecognized
gains are included in other comprehensive income.
Goodwill - Goodwill represents the excess cost over the fair value of net
tangible and identifiable intangible assets acquired, and a substantial portion
of the goodwill balance is associated with the acquisition of Heater Utilities,
Inc. in June 2004. Goodwill is not amortized but is tested for impairment
annually, or more often, if certain circumstances indicate a possible impairment
may exist. In accordance with the requirements of SFAS No. 142, "Goodwill and
Other Intangible Assets," the Company tested the goodwill attributable to each
of our reporting units for impairment as of June 30, 2004, in conjunction with
the timing of our annual strategic business plan. Based on the Company's
comparison of the estimated fair value of each reporting unit to their
respective carrying amounts, the impairment test concluded that none of its
goodwill was impaired.
30
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
Income Taxes - The Company accounts for certain income and expense items in
different time periods for financial reporting than for tax reporting purposes.
Deferred income taxes are provided on the temporary differences between the tax
basis of the assets and liabilities, and the amounts at which they are carried
in the consolidated financial statements. The income tax effect of temporary
differences not allowed currently in rates is recorded as deferred taxes with
an offsetting regulatory asset or liability. These deferred income taxes are
based on the enacted tax rates expected to be in effect when such temporary
differences are projected to reverse. Investment tax credits are deferred and
amortized over the estimated useful lives of the related properties.
Customers' Advances for Construction - Water mains or, in some instances, cash
advances to reimburse the Company for its costs to construct water mains, are
contributed to the Company by customers, real estate developers and builders in
order to extend water service to their properties. The value of these
contributions is recorded as Customers' Advances for Construction. The Company
makes refunds on these advances over a specific period of time based on
operating revenues related to the main or as new customers are connected to and
take service from the main. After all refunds are made, any remaining balance is
transferred to Contributions in Aid of Construction. Non-cash property, in the
form of water mains, has been received, generally from developers, as advances
or contributions of $9,273, $9,991 and $17,271 in 2004, 2003 and 2002,
respectively.
Contributions in Aid of Construction - Contributions in aid of construction
include direct non-refundable contributions and the portion of customers'
advances for construction that become non-refundable.
Inventories, Materials and Supplies - Inventories are stated at cost. Cost is
principally determined using the first-in, first-out method.
Stock-Based Compensation - The Company currently accounts for stock-based
compensation using the intrinsic value method in accordance with APB Opinion No.
25, "Accounting for Stock Issued to Employees". Accordingly, no compensation
expense related to granting of stock options has been recognized in the
financial statements for stock options that have been granted. Please refer to
the Recent Accounting Pronouncements section of this footnote for information
concerning changes to the Company's accounting for stock-based compensation.
Pursuant to the current disclosure requirements of SFAS No. 123, "Accounting for
Stock-Based Compensation," as amended by SFAS No. 148, pro forma net income
available to common stock and earnings per share are presented in the following
table as if compensation cost for stock options was determined as of the grant
date under the fair value method:
Years Ended December 31,
-------------------------------------
2004 2003 2002
-------------------------------------
Net income available to common stock, as reported $ 80,007 $ 70,785 $ 67,154
Add: stock-based employee compensation expense
included in reported net income, net of tax 266 224 473
Less: pro forma expense related to stock options
granted, net of tax effects (1,990) (1,793) (1,741)
------------------------------------
Pro forma $ 78,283 $ 69,216 $ 65,886
====================================
Basic net income per share:
As reported $ 0.86 $ 0.80 $ 0.78
Pro forma 0.84 0.78 0.77
Diluted net income per share:
As reported $ 0.85 $ 0.79 $ 0.78
Pro forma 0.83 0.78 0.76
31
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
The per share weighted-average fair value at the date of grant for
stock options granted during 2004, 2003 and 2002 was $5.43, $4.67 and $5.15 per
option, respectively. The fair value of options at the date of grant was
estimated using the Black-Scholes option-pricing model with the following
weighted average assumptions:
2004 2003 2002
--------------------------------
Expected life (years) 4.5 5.6 5.5
Interest rate 4.0% 3.7% 4.9%
Volatility 29.9% 32.4% 34.2%
Dividend yield 2.2% 2.6% 2.6%
Use of Estimates in Preparation of Consolidated Financial Statements - The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Recent Accounting Pronouncements - In May 2004, the Financial Accounting
Standards Board ("FASB") issued FASB Staff Position ("FSP") No. 106-2,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003." FSP 106-2 supersedes FSP
106-1, "Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003," which was issued
in January 2004 and permitted a sponsor of a postretirement health care plan
that provides a prescription drug benefit to make a one-time election to defer
accounting for the effects of the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Act") until more authoritative guidance on the
accounting for the federal subsidy was issued. The Company had elected the
one-time deferral allowed under FSP 106-1 and as a result adopted FSP 106-2 as
required in the third quarter of 2004 and it did not have a material impact on
our results of operations or financial position.
In November 2004, the FASB approved Statement of Financial Accounting
Standards ("SFAS") No. 151, "Inventory Costs - An Amendment of ARB No. 43,
Chapter 4." SFAS No. 151 requires the exclusion of certain costs from
inventories and the allocation of fixed production overheads to inventories to
be based on the normal capacity of the production facilities. The standard is
effective for the Company for costs incurred after December 31, 2005. The
Company believes this statement will not have a material impact on its results
of operations or financial position.
In November 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets - An Amendment of APB Opinion No. 29." SFAS No. 153
eliminates the exception for nonmonetary exchanges of similar productive assets
and replaces it with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. SFAS No. 153 specifies that a nonmonetary
exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. SFAS No. 153 is
effective for fiscal periods beginning after June 15, 2005. The Company believes
this statement will not have a material impact on its results of operations or
financial position.
On October 22, 2004, the American Jobs Creation Act ("AJCA") was signed
into law. Among other provisions, the AJCA creates a new deduction for qualified
domestic production activities. Certain activities of the Company, such as our
water treatment activity, are considered as qualifying production activities for
purposes of determining the deduction for qualified production activities. In
December 2004, the FASB issued FSP 109-1, "Application of FASB Statement No.
109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004." In accordance
with FSP 109-1, the Company will treat the deduction for qualified domestic
production activities as a reduction of the income tax provision in future years
as realized. The AJCA and FSP 109-1 did not impact the Company's 2004
consolidated financial statements. Thus, the Company is currently assessing the
impact, if any, of the AJCA and FSP 109-1 on its consolidated financial
statements in future periods. The Company believes the deduction could impact
the Company's future effective income tax rate and it is not expected to have a
material impact on its results of operations or financial position.
32
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment,"
which is effective for reporting periods beginning after June 15, 2005 (our
third quarter 2005 period). This standard revises SFAS No. 123, "Accounting for
Stock-based Compensation," and supersedes APB No. 25, "Accounting for Stock
Issued to Employees." As noted in the section captioned "Stock-based
Compensation" in the Summary of Significant Accounting Policies footnote, the
Company currently provides pro forma disclosure of its compensation costs
associated with the fair value of stock options that have been granted. The
Company currently accounts for stock-based compensation associated with stock
options using the intrinsic method, and accordingly, no compensation costs have
been recognized in its consolidated financial statements. SFAS 123R generally
requires that we measure the cost of employee services received in exchange for
stock-based awards on the grant-date fair value and this cost will be recognized
over the period during which an employee provides service in exchange for the
award. The fair value of the option grant will be estimated using an
option-pricing model. The Company is currently evaluating this standard to
determine the impact on its consolidated financial statements, including the
selection of an appropriate option-pricing model as permitted under SFAS No.
123R, and the method by which we will adopt SFAS No. 123R. The Company is
currently evaluating the requirements of SFAS No. 123R and it expects that the
adoption of this standard will have a material impact on its results of
operations and earnings per share.
33
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
Acquisitions
Heater - Pursuant to our strategy to grow through acquisitions, on June 1, 2004
the Company acquired the capital stock of Heater Utilities, Inc. for $48,000 in
cash and the assumption of long-term debt of $19,219 and short-term debt of
$8,500. The acquired operation provides water and wastewater service to over
50,000 water and wastewater customers primarily in the areas of suburban
Raleigh, Charlotte, Gastonia and Fayetteville, North Carolina. For the fiscal
year ended December 31, 2003, Heater had operating revenues of $19,489. The
acquisition was accounted for as a purchase and accordingly, the purchase price
is allocated to the net tangible and intangible assets based upon their
estimated fair values at the date of the acquisition. The Company obtained a
third-party valuation of these assets and liabilities, and it resulted in the
recording of a purchase accounting fair value adjustment of $3,141 to increase
the carrying-value of long-term debt assumed. The purchase price allocation is
as follows:
June 1,
2004
--------
Property, plant and equipment, net $ 96,779
Current assets 4,133
Other long-term assets 6,005
Goodwill 18,842
--------
Total assets acquired 125,759
--------
Current liabilities 3,063
Loans payable 8,500
Long-term debt 22,360
Other long-term liabilities 43,836
--------
Total liabilities assumed 77,759
--------
Net assets acquired $ 48,000
========
The Company has recorded goodwill of $18,842, and a substantial portion
of the goodwill is expected to be deductible for tax purposes. The purchase
price was arrived at through arms-length negotiations with the seller and is
consistent with the multiples paid in other comparable transactions. Aqua
America considered important regulatory, strategic and valuation considerations
in arriving at the final purchase price. During 2004, through the North Carolina
Utilities Commission approval process, a mechanism has been developed through
which the Company could recover up to two-thirds of the goodwill through
customer rates in the future upon achieving certain objectives. The Company
intends to pursue these objectives to facilitate recognition of this premium in
customer rates. However, there can be no assurance that the Company will be able
to achieve these objectives and recover such amount of goodwill, if any.
Florida Water - On June 30, 2004, the Company acquired certain utility assets of
Florida Water Services Corporation, comprised of 63 water and wastewater systems
located in central Florida for $14,747 in cash, which is less than the
depreciated original cost of these assets. In accordance with Florida
procedures, the acquisition remains subject to regulatory approval by the
Florida Public Service Commission. This process is not expected to be completed
prior to September 2005. Under the terms of the purchase agreement, the
Commission's review process may result in an adjustment of the final purchase
price, which would be settled in cash, based on the Commission's determination
of plant investment for the systems. Since the purchase price adjusts by the
change in the determined plant investment or rate base, effectively the rate
base adjustment is directly offset by the change in purchase price. The final
purchase price is not expected to result in the recognition of goodwill.
34
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
AquaSource - Pursuant to our strategy to grow through acquisitions, on July 31,
2003, the Company completed its acquisition of four operating water and
wastewater subsidiaries of AquaSource, Inc. (a subsidiary of DQE, Inc.),
including selected, integrated operating and maintenance contracts and related
assets (individually and collectively the acquisition is referred to as
"AquaSource") for $190,717 in cash, as adjusted pursuant to the purchase
agreement based on working capital at closing. On August 27, 2004, we were
awarded and received $12,289 plus interest in an arbitration related to the
calculation of the final purchase price under the terms of the purchase
agreement, which resulted in a final purchase price of $178,428. In the
consolidated statement of cash flow for 2004, the $12,289 award has been
reported as proceeds on the line titled acquisitions of water and wastewater
systems, net.
The results of AquaSource have been included in the Company's
consolidated financial statements beginning August 1, 2003. The acquired
operations of AquaSource serve over 130,000 water and wastewater customer
accounts in 11 states (including the Connecticut and Kentucky operations which
were subsequently sold to other parties). Please refer to the Dispositions
footnote for a discussion of the AquaSource operations located in Connecticut,
Kentucky and New York. The AquaSource acquisition was initially funded by a
portion of the proceeds from the July 2003 issuance of $135,000 of unsecured
notes due 2023, with an interest rate of 4.87%, and the issuance of a $90,000
unsecured note by Aqua America. In August 2003, the $90,000 unsecured note was
repaid with the proceeds from the issuance of 5,000,000 shares of common stock
through a shelf registration.
Under the purchase method of accounting, the purchase price is
allocated to AquaSource's net tangible and intangible assets based upon their
estimated fair values at the date of the acquisition. The purchase price
allocation, which reflects the effects of the August 2004 purchase price
arbitration proceeding, is as follows:
July 31,
2003
--------
Property, plant and equipment, net $197,719
Current assets 9,687
Other long-term assets 14,204
Assets held for sale, net 4,096
--------
Total assets acquired 225,706
--------
Current liabilities 8,214
Long-term debt 7,170
Other long-term liabilities 31,894
--------
Total liabilities assumed 47,278
--------
Net assets acquired $178,428
========
The following supplemental pro forma information is presented to
illustrate the effects of the AquaSource acquisition, which was completed on
July 31, 2003, on the historical operating results for the year ended December
31, 2003 and 2002 as if the acquisition had occurred at the beginning of the
respective periods (unaudited):
Years Ended
December 31,
-------------------------
2003 2002
-------------------------
Operating revenues $ 407,628 $ 391,569
Net income $ 74,436 $ 72,420
Net income per common share:
Basic $ 0.81 $ 0.80
Diluted $ 0.81 $ 0.79
35
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
The supplemental information is not necessarily representative of the
actual results that may have occurred for these periods or of the results that
may occur in the future. This information does not reflect the effects of recent
rate increases or cost savings that may result from the acquisition, such as the
effects of a reduction in administrative costs. This information is based upon
the historical operating results of AquaSource for periods prior to the
acquisition date of July 31, 2003 as provided to the Company by AquaSource, Inc.
and DQE, Inc. management.
Other Acquisitions - During 2004, in addition to the Heater and Florida Water
acquisitions, the Company completed 27 acquisitions or other growth ventures in
the various states in which the Company operates for an aggregate purchase price
of $3,842 in cash. The operating revenues included in the consolidated financial
statements of the Company during the period owned by the Company were $617.
During 2003, in addition to the AquaSource acquisition, the Company
completed 17 acquisitions or other growth ventures in the various states in
which the Company operates for an aggregate purchase price of $1,614 in cash.
Operating revenues included in the consolidated financial statements of the
Company related to these systems were $860 in 2004 and $312 in 2003.
During 2002, the Company completed 25 acquisitions or other growth
ventures in various states. The total purchase price of $11,659 for the systems
acquired in 2002 consisted of $8,914 in cash and the issuance of 178,864 shares
of the Company's common stock. Operating revenues included in the consolidated
financial statements of the Company related to the systems acquired in 2002 were
$2,932 in 2004, $2,920 in 2003 and $1,341 in 2002.
Dispositions
In December 2004, as a result of the settlement of a condemnation
action, the Company's Ohio operating subsidiary sold its water utility assets
within the municipal boundaries of the City of Geneva in Ashtabula County, Ohio
for net proceeds of approximately $4,716, which was in excess of the book value
for these assets. The proceeds were used to pay-down short-term debt and the
sale resulted in the recognition in the fourth quarter of 2004 of a gain on the
sale of these assets, net of expenses, of $2,342. The gain is reported in the
2004 consolidated statement of income as a reduction to operations and
maintenance expense. We continue to operate this water system for the City of
Geneva under an operating contract that began upon the closing of the sale for a
period through December 2006. The operating contract provides for an annual base
operating fee of $135 and allows for additional fees to be earned commensurate
with the services provided. These water utility assets represent less than 1% of
Aqua America's total assets, and the total number of customers included in the
water system sold represents less than 1% of our total customer base.
In July 2004, the Company sold it only operations in Kentucky. The sale
price approximates our investment in this operation. The operation represented
approximately 0.2% of the operations acquired from AquaSource, Inc. In October
2003, the Company sold its only operation in Connecticut. The sale price of
$4,000 approximates our investment in this operation. The operation represented
approximately 2% of the operations acquired from AquaSource, Inc. In May 2003,
the Company announced an agreement for the sale of the AquaSource regulated
operation located in New York to a New England-based water company. In January
2005, after the expiration of the sale agreement, the Company did not renew the
sale agreement. The New York operations represented approximately 1% of the
operations acquired from AquaSource, Inc.
In December 2002, as a result of the settlement of a condemnation
action, the Company's Ohio operating subsidiary sold to Ashtabula County, Ohio
the water utility assets in the unincorporated areas of Ashtabula County and the
area within the Village of Geneva on the Lake for $12,118, net of certain
closing costs. The sale was in excess of the book value for these assets and the
sale generated a gain of $5,676 (or an after-tax
36
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
gain of $3,690 and $0.04 per share) recorded in the fourth quarter of 2002. We
continue to operate this water system for Ashtabula County, beginning after the
closing of the sale, under a multi-year operating contract. The water utility
assets sold represent less than 1% of our total assets, and the total number of
customers included in the water system sold represents less than 1% of our total
customer base.
The City of Fort Wayne, Indiana has authorized the acquisition, by
eminent domain or otherwise, of a portion of the utility assets of one of the
operating subsidiaries that the Company acquired in connection with the
AquaSource acquisition in 2003. The Company has challenged whether the City is
following the correct legal procedures in connection with the City's attempted
condemnation and the Company has challenged the City's valuation of this portion
of its system. The portion of the system under consideration represents
approximately 1% of the Company's total customer base. While the Company
continues to discuss this matter with officials from the City of Fort Wayne, the
Company continues to protect its interests in this proceeding. The Company
believes that it will be entitled to fair market value for its assets if they
are condemned, and it is believed that the fair market value will be in excess
of the book value for such assets.
Property, Plant and Equipment
December 31,
-------------------------- Approximate range
2004 2003 of remaining lives
-------------------------- ------------------
Utility plant and equipment:
Mains and accessories $1,087,712 $ 962,439 15 to 85 years
Services, hydrants, treatment
plants and reservoirs 607,331 547,622 5 to 56 years
Operations structures and water tanks 218,888 175,663 15 to 61 years
Miscellaneous pumping and
purification equipment 342,985 259,468 10 to 50 years
Meters, data processing, transportation
and operating equipment 298,015 251,721 5 to 50 years
Land and other non-depreciable assets 67,260 58,223 -
--------------------------
Utility Plant and equipment 2,622,191 2,255,136
Utility construction work in progress 63,754 92,106 -
Net utility plant acquisition adjustment (63,347) (48,054) 0 to 20 years
Non-utility plant and equipment 3,553 3,116 2 to 40 years
--------------------------
Total property, plant and equipment $2,626,151 $2,302,304
==========================
Accounts Receivable
December 31,
--------------------------
2004 2003
--------------------------
Billed utility revenue $ 39,783 $ 41,843
Unbilled utility revenue 27,927 23,876
Other 1,677 2,452
--------------------------
69,387 68,171
Less allowance for doubtful accounts 4,849 5,851
--------------------------
Net accounts receivable $ 64,538 $ 62,320
==========================
The Company's customers are located principally in the following
states: 49% in Pennsylvania, 10% in Ohio, 8% in North Carolina, 8% in Illinois,
6% in Texas, 5% in New Jersey, 4% in Florida, and 4% in Indiana. No single
37
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
customer accounted for more than one percent of the Company's operating revenues
during the years ended December 31, 2004, 2003 or 2002. The following table
summarizes the changes in the Company's allowance for doubtful accounts:
2004 2003 2002
-----------------------------------
Balance at January 1, $ 5,851 $ 3,580 $ 2,482
Amounts charged to expense 2,621 2,643 3,182
Accounts written off (4,255) (2,715) (2,375)
Recoveries of accounts written off 556 253 291
Allowance acquired through acquisitions 76 2,090 -
-----------------------------------
Balance at December 31, $ 4,849 $ 5,851 $ 3,580
===================================
Regulatory Assets and Liabilities
The regulatory assets represent costs that are expected to be fully
recovered from customers in future rates while regulatory liabilities represent
amounts that are expected to be refunded to customers in future rates or amounts
recovered from customers in advance of incurring the costs. Except for income
taxes and the competitive transition charge payment, regulatory assets and
regulatory liabilities are excluded from the Company's rate base and do not earn
a return. The components of regulatory assets and (liabilities) are as follows:
December 31,
------------------------
2004 2003
------------------------
Income taxes, asset $ 68,990 $ 68,917
Income taxes, liability (3,283) (3,434)
CTC payment 6,879 8,026
Postretirement benefits 11,403 6,698
Merger costs 2,170 2,700
Water tank painting 4,593 3,240
Utility plant retirement costs, asset 14,729 13,699
Utility plant retirement costs, liability (8,184) (7,484)
Rate case filing expenses & other 13,696 6,399
----------------------
$110,993 $ 98,761
======================
Items giving rise to deferred state income taxes, as well as a portion
of deferred Federal income taxes related to certain differences between tax and
book depreciation expense, are recognized in the rate setting process on a cash
or flow-through basis and will be recovered as they reverse. The regulatory
asset associated with the Competitive Transition Charge ("CTC") payment
represents the full payoff in 2001, net of amortization, of the allocable share
of a CTC as negotiated by Aqua Pennsylvania, Inc. from its electric distribution
company, PECO Energy Company. The Pennsylvania Electricity Generation Customer
Choice and Competition Act permitted electric distribution utilities to recover
their stranded costs from its customers in the form of a CTC. Rate recovery of
the $11,465 CTC payment began in 2000 and is expected to conclude in 2010.
Postretirement benefits include pension and other postretirement
benefits. The pension costs include deferred net pension expense in excess of
amounts funded which the Company believes will be recoverable in future years as
pension funding is required, and in addition includes an additional minimum
liability for pensions as a result of a decline in the discount rate assumed for
pension obligations and a change in the fair market value of plan assets. The
additional minimum liability equals the excess of the accumulated benefit
obligation over the fair value of plan assets. The regulatory asset related to
postretirement benefits other than pensions represents costs that were deferred
between the time that the accrual method of accounting for these benefits was
adopted in 1993 and the recognition of the accrual method in the Company's rates
as prescribed in subsequent rate filings. Amortization of the amount deferred
for postretirement benefits other than pensions began in 1994 and is currently
being recovered in rates.
38
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
The regulatory asset related to the recovery of merger costs represents
the portion of the Consumers Water Company merger costs that will be recovered
in rates as a result of a rate settlement in 2000 and is being amortized over
the recovery period. Expenses associated with water tank painting are deferred
and amortized over a period of time as approved in the regulatory process. The
regulatory asset for utility plant retirement costs, including cost of removal,
represents costs already incurred that are expected to be recovered in future
rates over a five year recovery period. The regulatory liability for utility
plant retirement costs represents amounts recovered through rates during the
life of the associated asset and before the costs are incurred. The regulatory
asset related to rate case filing expenses represents the costs associated with
filing for rate increases that are deferred and amortized over periods that
generally range from one to five years.
Income Taxes
The provision for income taxes consists of:
Years Ended December 31,
-------------------------------------
2004 2003 2002
-------------------------------------
Current:
Federal $ 2,042 $ 11,933 $ 16,619
State 7,553 7,249 6,647
-------------------------------------
9,595 19,182 23,266
-------------------------------------
Deferred:
Federal 41,414 25,521 17,921
State 1,115 1,220 859
-------------------------------------
42,529 26,741 18,780
-------------------------------------
Total tax expense $ 52,124 $ 45,923 $ 42,046
=====================================
The statutory Federal tax rate is 35% and for states with a corporate
net income tax, the state corporate net income tax rates range from 5.00% to
9.99% for all years presented. The Company's Federal income tax returns for all
years through 2000 have been closed, and 2002 was closed as a result of the
conclusion of a tax audit.
The reasons for the differences between amounts computed by applying
the statutory Federal income tax rate to income before income tax expense are as
follows:
Years Ended December 31,
------------------------------------
2004 2003 2002
------------------------------------
Computed Federal tax expense at statutory rate $ 46,245 $ 40,852 $ 38,238
Increase in tax expense for depreciation expense
to be recovered in future rates 1,376 1,125 558
Merger transaction costs (24) (96) (680)
Charitable contribution - (424) (98)
Deduction for Aqua America common dividends
paid under employee benefit plan (245) (241) (207)
Amortization of deferred investment tax credits (285) (285) (283)
Prior year rate reductions (538) (431) (315)
State income taxes, net of federal tax benefit 5,634 5,505 4,879
Other, net (39) (82) (46)
------------------------------------
Actual income tax expense $ 52,124 $ 45,923 $ 42,046
====================================
39
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
The tax effects of temporary differences between book and tax
accounting that give rise to the deferred tax assets and deferred tax
liabilities are as follows:
December 31,
------------------------
2004 2003
------------------------
Deferred tax assets:
Customers' advances for construction $ 17,057 $ 17,133
Costs expensed for book not deducted
for tax, principally accrued expenses 1,989 6,525
Utility plant acquisition adjustment
basis differences 30,920 21,784
Minimum pension liability adjustment 938 -
------------------------
Total gross deferred tax assets 50,904 45,442
------------------------
Deferred tax liabilities:
Utility plant, principally due to
depreciation and differences in the basis
of fixed assets due to variation in tax
and book accounting 243,953 203,706
Deferred taxes associated with the gross-up
of revenues necessary to recover, in rates,
the effect of temporary differences 23,670 24,634
Deferred investment tax credit 6,328 6,618
Unrealized gain on marketable securities - 141
Other 840 738
------------------------
Total gross deferred tax liabilities 274,791 235,837
------------------------
Net deferred tax liability $223,887 $190,395
========================
On October 22, 2004, the American Jobs Creation Act ("AJCA") was signed
into law. Among other provisions, the AJCA creates a new deduction for qualified
domestic production activities. Certain activities of the Company, such as our
water treatment activity, are considered as qualifying production activities for
purposes of determining the deduction for qualified production activities. The
AJCA did not impact the Company's 2004 consolidated financial statements. Thus,
the Company is currently assessing the impact, if any, of the AJCA on its
consolidated financial statements in future periods. See Summary of Significant
Accounting Policies - Recent Accounting Pronouncements for a discussion of the
AJCA.
Commitments
The Company maintains agreements with other water purveyors for the
purchase of water to supplement its water supply, particularly during periods of
peak demand. The agreements stipulate purchases of minimum quantities of water
to the year 2026. The estimated annual commitments related to such purchases are
expected to approximate $10,924 through 2009 and $82,388 thereafter. The Company
purchased approximately $8,724, $8,014 and $7,079 of water under these
agreements during the years ended December 31, 2004, 2003 and 2002,
respectively.
The Company leases motor vehicles, buildings and other equipment under
operating leases that are noncancelable. The future annual minimum lease
payments due are: $2,452 in 2005, $1,833 in 2006, $1,192 in 2007, $857 in 2008,
$488 in 2009 and $692 thereafter. The Company leases parcels of land on which
treatment plants and other facilities are situated and adjacent parcels that are
used for watershed protection. The operating leases are noncancelable, expire
between 2012 and 2052 and contain certain renewal provisions. Certain leases are
subject to an adjustment every five years based on changes in the Consumer Price
Index. Subject to the aforesaid adjustment, during each of the next five years,
approximately $477 of annual lease payments for land are due, and $15,215
thereafter. The Company leases treatment plants to other parties under lease
agreements that require payments to the Company of $567 in 2005, $567 in 2006,
$267 in 2007, $308 in 2008, $246 in 2009 and $3,676 thereafter.
40
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
Rent expense was $3,267, $2,993 and $2,182 for the years ended December
31, 2004, 2003 and 2002, respectively.
Long-term Debt and Loans Payable
The Consolidated Statements of Capitalization provides a summary of
long-term debt and loans outstanding as of December 31, 2004 and 2003. The
supplemental indentures with respect to certain issues of the First Mortgage
Bonds restrict the ability of Aqua Pennsylvania, Inc. and certain other
operating subsidiaries of the Company to declare dividends, in cash or property,
or repurchase or otherwise acquire the stock of these companies. As of December
31, 2004, approximately $249,000 of Aqua Pennsylvania's retained earnings and
$62,000 of the retained earnings of certain other subsidiaries were free of
these restrictions. Certain supplemental indentures also prohibit Aqua
Pennsylvania and certain other subsidiaries of the Company from making loans to,
or purchasing the stock of, the Company.
Annual sinking fund payments are required for certain issues of First
Mortgage Bonds by the supplemental indentures. The future sinking fund payments
and debt maturities of the Company's long-term debt are as follows:
Interest Rate Range 2005 2006 2007 2008 2009 Thereafter
-----------------------------------------------------------------------------
0.00% to 2.49% $ 1,267 $ 1,337 $ 1,351 $ 1,364 $ 1,388 $ 13,344
2.50% to 2.99% 1,453 6,495 1,529 1,572 1,619 17,256
3.00% to 3.49% 267 266 12,273 280 290 4,170
3.50% to 3.99% 679 689 700 710 722 3,623
4.00% to 4.99% - 50 50 50 55 144,230
5.00% to 5.49% - - - - - 165,615
5.50% to 5.99% - - - - - 89,260
6.00% to 6.49% - 144 644 10,172 - 100,360
6.50% to 6.99% 10,000 10,000 10,000 - - 12,000
7.00% to 7.49% 28,500 2,539 2,580 2,625 714 8,147
7.50% to 7.99% 180 194 210 227 245 24,175
8.00% to 8.49% 126 138 152 167 184 25,947
8.50% to 8.99% - - - - - 9,000
9.00% to 9.49% 6,568 576 584 594 604 44,318
9.50% to 9.99% 1,155 2,195 995 5,995 995 30,753
10.00% to 10.50% - - - - - 6,000
-----------------------------------------------------------------------------
Total $ 50,195 $ 24,623 $ 31,068 $ 23,756 $ 6,816 $ 698,198
=============================================================================
Aqua Pennsylvania had a five-year $300,000 medium-term note program
that expired in December 2004 that provided for the issuance of long-term debt
with maturities ranging between one and 35 years at fixed rates of interest, as
determined at the time of issuance. The bonds issued under this program were
secured by the Thirty-Third Supplement to the trust indenture relating to Aqua
Pennsylvania's First Mortgage Bonds. In May 2004, Aqua Pennsylvania issued
$87,000 of First Mortgage Bonds through the program with a weighted-average
interest rate of approximately 5.1% and a weighted-average maturity of 13.7
years. The proceeds from this issuance were used to refinance short-term debt
and to fund long-term debt maturities.
41
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
In May 2004, an unsecured note of $70,000 was issued by the Company.
Interest under this note is based, at the borrower's option, on either a defined
base rate or an adjusted London Interbank Offered Rate corresponding to the
interest period selected. The proceeds of this financing were used to fund
acquisitions and to refinance existing debt. In November 2004, $34,000 of the
$70,000 unsecured note was repaid with the proceeds from an equity offering. The
remaining balance of the note of $36,000 is classified as loans payable. In
connection with the acquisition of Heater Utilities, Inc. in June 2004, the
Company assumed $22,360 of long-term debt at interest rates ranging from 7.05%
to 8.24% due 2012 to 2025, which includes the purchase accounting fair value
adjustment of $3,141, increasing the carrying-value of long-term debt. In
November 2004, Aqua Pennsylvania issued $14,000 tax-exempt bonds due 2039 at a
rate of 5.05% and secured by a supplement to the trust indenture relating to
Aqua Pennsylvania's First Mortgage Bonds. The proceeds from the bonds issued
were used to retire previously issued tax-exempt bonds. At various times during
2004, Aqua Pennsylvania and other operating subsidiaries issued other notes
payable and first mortgage bonds in aggregate of $31,239 at a weighted-average
interest rate of 3.76% due at various times ranging from 2006 to 2037. The
proceeds from these issuances were used to reduce a portion of the balance of
the short-term debt at each of the respective operating subsidiaries and to
redeem $6,000 of first mortgage bonds with a weighted-average interest rate of
9.19%. As of December 31, 2004, the Trustees for eight issues held $17,196
pending completion of the projects financed with the issues and are reported in
the consolidated balance sheet as funds restricted for construction activity.
In July 2003, the Company issued $135,000 of unsecured notes due 2023
and with an interest rate of 4.87%. The proceeds of this financing were used to
fund the acquisition of the AquaSource operations and to refinance existing
debt. In July 2003, the Company also issued a $90,000 unsecured note payable and
the proceeds were also used to fund the acquisition of the AquaSource
operations. In August 2003, the $90,000 note payable was repaid with the
proceeds from an equity offering. At various times during 2003, Aqua
Pennsylvania, other operating subsidiaries and the Company issued other notes
payable and first mortgage bonds in aggregate of $27,894 at a weighted average
interest rate of 4.50% due at various times ranging from 2013 to 2032. The
proceeds from these issuances were used to reduce a portion of the balance of
the short-term debt at each of the respective operating subsidiaries, to redeem
$7,000 of first mortgage bonds of operating subsidiaries with a weighted average
interest rate of 6.35% and redeem the Company's preferred stock of $172. In
connection with the acquisition of the AquaSource operations in July 2003, the
Company assumed $8,131 of long-term debt of which $7,415 was retired during
2003. The weighted average cost of long-term debt at December 31, 2004 and 2003
was 6.00% and 6.19%, respectively.
Aqua Pennsylvania has a $70,000 364-day revolving credit
facility with four banks and the Company has a $20,000 364-day bank revolving
credit facility. Funds borrowed under these agreements are classified as loans
payable and are used to provide working capital. As of December 31, 2004 and
2003, funds borrowed under the Aqua Pennsylvania revolving credit agreements
were $29,000 and $52,068, respectively, and $0 and $19,801 were borrowed under
the Company's revolving credit agreement, respectively. Interest under these
facilities is based, at the borrower's option, on the prime rate, an adjusted
federal funds rate, an adjusted London Interbank Offered Rate corresponding to
the interest period selected, an adjusted Euro-Rate corresponding to the
interest period selected or at rates offered by the banks. These agreements
restrict the total amount of short-term borrowings of Aqua Pennsylvania and the
Company. A commitment fee ranging from 1/4 to 1/10 of 1% is charged on the
unused portion of the revolving credit agreements. The average cost of borrowing
under these facilities was 1.4% and 1.6%, and the average borrowing was $50,115
and $62,528, during 2004 and 2003, respectively. The maximum amount outstanding
at the end of any one month was $89,519 in 2004 and $73,079 in 2003.
At December 31, 2004 and 2003, the Company had combined short-term
lines of credit of $108,000 and $88,000, respectively. Funds borrowed under
these lines are classified as loans payable and are used to provide working
capital. As of December 31, 2004 and 2003, funds borrowed under the short-term
lines of credit were $9,810 and $24,590, respectively. The average borrowing
under the lines was $34,711 and $50,353 during 2004 and 2003, respectively. The
maximum amount outstanding at the end of any one month was $51,288 in 2004 and
$73,700 in 2003. Interest under the lines is based at the Company's option,
depending on the line, on the prime rate, an adjusted Euro-Rate, an adjusted
federal funds rate or at rates offered by the banks. The average cost of
borrowings under all lines during 2004 and 2003 was 2.3% and 2.4%, respectively.
42
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
Interest income of $1,762, $395 and $287 was netted against interest
expense on the consolidated statements of income for the years ended December
31, 2004, 2003 and 2002, respectively. The total interest cost was $50,441,
$45,057 and $40,683 in 2004, 2003 and 2002, including amounts capitalized of
$2,304, $2,127 and $1,389, respectively.
Fair Value of Financial Instruments
The carrying amount of current assets and liabilities that are
considered financial instruments approximates their fair value as of the dates
presented. The carrying amount and estimated fair value of the Company's
long-term debt are as follows:
December 31,
----------------------------
2004 2003
----------------------------
Carrying amount $834,656 $736,052
Estimated fair value 863,247 781,502
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. The Company's customers' advances for
construction and related tax deposits have a carrying value of $73,095 and
$72,500 at December 31, 2004 and 2003, respectively. 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 2017 and amounts not paid by the 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.
Preferred Stock
At December 31, 2004, the Company had 1,770,819 shares of Series
Preferred Stock with a $1.00 par value authorized, of which 100,000 shares are
designated as Series A Preferred Stock. During 1996, the Company designated and
issued in connection with an acquisition 32,200 shares as Series B Preferred
Stock, $1.00 par value. The Series B Preferred Stock was recorded on the
consolidated balance sheet at its liquidation value of $100 per share. In
December 2003, the remaining shares of Series B Preferred Stock were redeemed as
provided under the provisions of the issue through the issuance of debt of $960
with a five-year maturity at an interest rate of 6.05% per annum. The Series A
Preferred Stock, as well as the undesignated shares of Series Preferred Stock,
remains unissued. As of December 31, 2004, the Company did not have any
preferred stock outstanding.
Stockholders' Equity
At December 31, 2004, the Company had 300,000,000 shares of common
stock authorized; par value $0.50. Shares outstanding at December 31, 2004, 2003
and 2002 were 95,384,833, 92,589,040 and 84,895,543, respectively. Treasury
shares held at December 31, 2004, 2003 and 2002 were 686,747, 681,384 and
2,151,350, respectively.
The Company has a universal shelf registration with the Securities and
Exchange Commission to allow for the sale, over time, of up to $250,000 of
various debt and equity securities, including common stock. The Company has
issued common stock in these transactions under the universal shelf
registration:
o In November 2004, the Company issued 1,955,000 shares of common stock in a
public offering for proceeds of $42,600, net of expenses. The net proceeds
were used to repay a portion of our short-term debt. The indebtedness was
incurred by Aqua America in connection with acquisitions.
43
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
o In August 2003, the Company issued 5,000,000 shares of common stock in a
public offering for proceeds of $90,100, net of expenses. The net proceeds
were used to repay an unsecured note of $90,000. The indebtedness was
incurred by Aqua America in connection with the acquisition of the
operations that were purchased from AquaSource, Inc.
o In May 2003, the Company issued 1,868,750 shares of common stock in a
public offering for proceeds of $33,100, net of expenses. The net proceeds
were used to repay short-term debt, including the repayment of $22,000 of
indebtedness incurred in connection with the Company's repurchase of
1,513,275 shares of common stock from affiliates of Veolia Environnement,
S.A. (formerly Vivendi Environnement, S.A.) in October 2002.
The balance remaining available for use under the universal shelf
registration as of December 31, 2004 is $77,517. In addition, the Company has a
shelf registration statement filed with the Securities and Exchange Commission
to permit the offering from time to time of shares of common stock and shares of
preferred stock for acquisitions. During 2002, 178,664 shares of common stock
totaling $2,745 were issued by the Company to acquire water and wastewater
systems. The balance remaining available for use under the acquisition shelf
registration as of December 31, 2004 is 2,218,947 shares. The form and terms of
such securities shall be determined when and if these securities are issued
under these shelf registrations.
In May 2002, Veolia Environnement, S.A. which through its affiliates
(collectively "VE") owned approximately 16.8% of our outstanding common stock,
advised the Company of their decision to sell its investment in Aqua America,
Inc. VE announced that its decision was part of its overall strategy to divest
non-core assets and focus on other business strategies. In September 2002, in
order to facilitate the orderly re-distribution of the shares held by VE into
the market, the Company completed a secondary offering of 12,356,570 shares of
Aqua America common stock held by VE. The number of outstanding shares of common
stock was not changed and the Company did not receive any proceeds as a result
of this secondary offering. In addition, in October 2002 the Company repurchased
1,513,275 shares of Aqua America, Inc. common stock representing the remainder
of the shares of Aqua America, Inc. common stock held by VE. The repurchase of
shares was funded with proceeds of $22,000 from a short-term credit facility. In
May 2003, this $22,000 short-term credit facility was repaid with a portion of
the funds from the issuance of 1,868,750 shares of common stock through a shelf
registration as described above.
In addition, the Board of Directors has authorized the Company to
purchase its common stock, from time to time, in the open market or through
privately negotiated transactions. The Company has not repurchased any shares
under this authorization since 2000. As of December 31, 2004, 411,209 shares
remain available for purchase by the Company.
The Company has a Dividend Reinvestment and Direct Stock Purchase Plan
("Plan") that allows reinvested dividends to be used to purchase shares of
common stock at a five percent discount from the current market value. Under the
direct stock purchase program, shares are purchased by investors at market
price. The shares issued under the Plan are either original issue shares or
shares purchased by the Company's transfer agent in the open-market. During
2004, 2003 and 2002, under the dividend reinvestment portion of the Plan,
384,457, 395,605 and 402,084 original issue shares of common stock were sold
providing the Company with proceeds of $7,808, $7,000 and $6,407, respectively.
The Company reports comprehensive income in accordance with SFAS No.
130, "Reporting Comprehensive Income." Accordingly, the Company's accumulated
other comprehensive income is reported in the Stockholders' Equity section of
the Consolidated Balance Sheets, the Consolidated Statements of Stockholders'
Equity and the related other comprehensive income is reported in the
Consolidated Statements of Income and Comprehensive Income. The Company reports
its unrealized gains on securities and minimum pension liability adjustments as
other comprehensive income or loss and accumulated other comprehensive income or
loss.
44
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
Net Income per Common Share and Equity per Common Share
Basic net income per share is based on the weighted average number of
common shares outstanding. Diluted net income per share is based on the weighted
average number of common shares outstanding and potentially dilutive shares. The
dilutive effect of employee stock options is included in the computation of
Diluted net income per share. The following table summarizes the shares, in
thousands, used in computing Basic and Diluted net income per share:
Years ended December 31,
---------------------------------
2004 2003 2002
---------------------------------
Average common shares outstanding during
the period for Basic computation 93,247 88,275 85,674
Dilutive effect of employee stock options 1,035 969 864
---------------------------------
Average common shares outstanding during
the period for Diluted computation 94,282 89,244 86,538
=================================
For the year ended December 31, 2004, employee stock options
outstanding to purchase 569,900 shares of common stock were excluded from the
calculation of diluted net income per share as the options' exercise price was
greater than the average market price of the Company's common stock. For the
years ended December 31, 2003 and 2002, there were no outstanding employee stock
options excluded from the calculation of diluted net income per share as the
average market price of the Company's common stock was greater than the options'
exercise price.
Equity per common share was $7.83 and $7.11 at December 31, 2004 and
2003, respectively. These amounts were computed by dividing common stockholders'
equity by the number of shares of common stock outstanding at the end of each
year.
Shareholder Rights Plan
The Company has a Shareholder Rights Plan designed to protect the
Company's shareholders in the event of an unsolicited unfair offer to acquire
the Company. Each outstanding common share is entitled to one Right which is
evidenced by the common share certificate. In the event that any person acquires
20% or more of the outstanding common shares or commences a tender or exchange
offer which, if consummated, would result in a person or corporation owning at
least 20% of the outstanding common shares of the Company, the Rights will begin
to trade independently from the common shares and, if certain circumstances
occur, including the acquisition by a person of 20% or more of the outstanding
common shares, each Right would then entitle its holder to purchase a number of
common shares of the Company at a substantial discount. If the Company is
involved in a merger or other business combination at any time after the Rights
become exercisable, the Rights will entitle the holder to acquire a certain
number of shares of common stock of the acquiring company at a substantial
discount. The Rights are redeemable by the Company at a redemption price of $.01
per Right at any time before the Rights become exercisable. The Rights will
expire on March 1, 2008, unless previously redeemed.
Employee Stock and Incentive Plan
In May 2004, the 2004 Equity Compensation Plan ("the 2004 Plan") was
approved by the shareholders to replace the 1994 Equity Compensation Plan ("the
1994 Plan"), the Company may grant qualified and non-qualified stock options to
officers, key employees and consultants. Officers and key employees may also be
granted dividend equivalents and restricted stock. Restricted stock may also be
granted to non-employee members of the Board of Directors ("Board"). The 2004
Plan authorizes 3,675,000 shares for issuance under the Plan. A maximum of 50%
of the shares available for issuance under the 2004 Plan may be issued as
restricted stock and the maximum number of shares that may be subject to grants
under the plans to any one individual in any one year is 150,000. Awards under
the 2004 Plan are, and awards under the 1994 plan were, made by a committee of
the Board of Directors.
45
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
Options under the plans were issued at the market price of the stock on
the day of the grant. Options are exercisable in installments of 33% annually,
starting one year from the date of the grant and expire 10 years from the date
of the grant. The following table summarizes stock option transactions for the
plans:
As of or For the Years Ended December 31,
----------------------------------------------------------------------------------
2004 2003 2002
-------------------------- -------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------------------------- -------------------------- --------------------------
Options:
Outstanding, beginning of year 2,993,421 $ 13.31 2,830,133 $ 12.06 2,559,763 $ 10.66
Granted 582,650 21.53 613,654 16.98 617,813 16.64
Terminated (98,286) 16.63 (15,533) 14.78 (8,265) 12.99
Exercised (427,548) 11.95 (434,833) 10.28 (339,178) 9.82
------------------------- ------------------------- -------------------------
Outstanding, end of year 3,050,237 $ 14.96 2,993,421 $ 13.31 2,830,133 $ 12.06
========================= ========================= =========================
Exercisable, end of year 1,911,805 $ 12.43 1,756,300 $ 11.01 1,555,483 $ 9.70
========================= ========================= =========================
Options exercised during 2004 ranged in price from $4.56 per
share to $21.53 per share. At December 31, 2004, 3,678,584 options under the
2004 Plan were still available for grant, although under the terms of the 2004
Plan, terminated, expired or forfeited grants under the 1994 Plan and shares
withheld to satisfy tax withholding requirements under the 1994 Plan may be
re-issued under the 2004 Plan. The following table summarizes the price ranges
of the options outstanding and options exercisable as of December 31, 2004:
Options Outstanding Options Exercisable
---------------------------------------- ----------------------------
Weighted Weighted Weighted
Average Average Average
Remaining Exercise Exercise
Shares Life (years) Price Shares Price
---------------------------------------- ----------------------------
Range of prices:
$ 4.56 - 7.99 342,302 1.4 $ 6.25 342,302 $ 6.25
$ 8.00 - 9.99 245,471 5.3 9.39 245,471 9.39
$10.00 - 12.99 396,510 3.9 11.10 396,510 11.10
$13.00 - 15.99 433,175 6.3 15.28 433,175 15.28
$16.00 - 16.99 941,578 7.9 16.65 454,295 16.65
$17.00 - 21.53 691,201 9.1 20.97 40,052 18.33
--------------------------------------- ---------------------------
3,050,237 6.5 $ 14.96 1,911,805 $ 12.43
======================================= ===========================
Under SFAS No. 123 "Accounting for Stock-Based Compensation" and SFAS
No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure",
the Company currently applies the provisions of APB Opinion No. 25 and provides
the pro forma disclosure provisions of this statement. Accordingly, no
compensation cost has been recognized in the financial statements for stock
options that have been granted. Pursuant to the disclosure requirements of SFAS
No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148,
pro forma net income available to common stock and earnings per share are
presented in the Summary of Significant Accounting Policies - Stock-Based
Compensation as if compensation cost for stock options was determined as of the
grant date under the fair value method. In December 2004, the FASB issued SFAS
No. 123R, "Share-Base Payment" which will change the Company's accounting for
the compensation costs for its stock options granted as described in the Summary
of Significant Accounting Policies - Recent Accounting Pronouncements.
46
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
Restricted stock awards provide the grantee with the rights of a
shareholder, including the right to receive dividends and to vote such shares,
but not the right to sell or otherwise transfer the shares during the
restriction period. During 2004, 2003 and 2002, 34,151, 20,156 and 37,031 shares
of restricted stock were granted with a restriction period ranging from six to
36 months. The value of restricted stock awards, which are "compensatory", is
equal to the fair market value of the stock on the date of the grant and is
amortized ratably over the restriction period. The company recorded compensation
expense related to restricted stock awards of $439, $369 and $769 during 2004,
2003 and 2002, respectively.
Pension Plans and Other Postretirement Benefits
The Company maintains a qualified, defined benefit pension plan that
covers a majority of its full-time employees who were hired prior to April 1,
2003. Retirement benefits under the plan are generally based on the employee's
total years of service and compensation during the last five years of
employment. The Company's policy is to fund the plan annually at a level which
is deductible for income tax purposes and which provides assets sufficient to
meet its pension obligations. To offset certain limitations imposed by the
Internal Revenue Code with respect to payments under qualified plans, the
Company has a non-qualified Excess Benefit Plan for Salaried Employees in order
to prevent certain employees from being penalized by these limitations. The
Company also has non-qualified Supplemental Executive Retirement Plans for
certain current and retired employees. The net pension costs and obligations of
the qualified and non-qualified plans are included in the tables which follow.
Employees hired after April 1, 2003 may participate in a defined contribution
plan that provides a Company matching contribution on amounts contributed by
participants and an annual profit-sharing contribution based upon a percentage
of the eligible participants' compensation.
In addition to providing pension benefits, the Company offers certain
Postretirement Benefits other than Pensions ("PBOPs") to employees hired before
April 1, 2003 and retiring with a minimum level of service. These PBOPs include
continuation of medical and prescription drug benefits for eligible retirees and
life insurance benefits for certain eligible retirees. The Company funds its
gross PBOP cost through various trust accounts. The benefits of retired officers
and certain other retirees are paid by the Company and not from plan assets due
to limitations imposed by the Internal Revenue Code.
The following benefit payments, which reflect expected future service,
as appropriate, are expected to be paid in the years indicated:
Other
Pension Postretirenent
Benefits Benefits
--------- ---------
Years:
2005 $ 6,453 $ 1,852
2006 6,541 1,950
2007 6,747 2,047
2008 7,129 2,176
2009 7,452 2,310
2010 - 2014 47,220 14,012
In May 2004, the FASB issued FASB Staff Position ("FSP") No. 106-2,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003." FSP 106-2 supersedes FSP
106-1, "Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003," which was issued
in January 2004 and permitted a sponsor of a postretirement health care plan
that provides a prescription drug benefit to make a one-time election to defer
accounting for the effects of the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Act") until more authoritative guidance on the
accounting for the federal subsidy was issued. The Company had elected the
one-time deferral allowed under FSP 106-1 and as a result adopted FSP 106-2 as
required in the third quarter of 2004 and it did not have a material impact on
our results of operations or financial position.
47
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
The changes in the benefit obligation and fair value of plan assets,
the funded status of the plans and the assumptions used in the measurement of
the company's benefit obligation are as follows:
Other
Pension Benefits Postretirement Benefits
----------------------- -----------------------
2004 2003 2004 2003
-------- -------- ------- -------
Change in benefit obligation:
Benefit obligation at January 1, $150,098 $131,059 $29,134 $25,436
Service cost 4,312 3,627 1,112 987
Interest cost 9,512 8,999 1,825 1,703
Plan amendments 567 - 6 -
Actuarial loss 12,742 12,222 1,676 1,978
Plan participants' contributions - - 631 513
Benefits paid (6,155) (5,809) (1,580) (1,483)
-------- -------- ------- -------
Benefit obligation at December 31, 171,076 150,098 32,804 29,134
-------- -------- ------- -------
Change in plan assets:
Fair value of plan assets at January 1, 108,731 94,438 14,391 12,200
Actual return on plan assets 8,535 20,021 641 816
Employer contributions 4,181 81 2,522 2,345
Benefits paid (6,155) (5,809) (948) (970)
-------- -------- ------- -------
Fair value of plan assets at December 31, 115,292 108,731 16,606 14,391
-------- -------- ------- -------
Funded status of plan:
Funded status at December 31, 55,784 41,367 16,198 14,743
Unrecognized actuarial loss (41,531) (29,164) (6,853) (4,857)
Unrecognized prior service cost (2,090) (1,942) 527 590
Unrecognized net transition obligation 1,017 1,227 (6,428) (7,231)
-------- -------- ------- -------
Net amount recognized $ 13,180 $ 11,488 $ 3,444 $ 3,245
======== ======== ======= =======
The Company's pension plans had an accumulated benefit obligation of
$136,851 and $121,521 at December 31, 2004 and 2003, respectively. The following
table provides the net liability recognized on the Consolidated Balance Sheets
at December 31,:
Other
Pension Benefits Postretirement Benefits
---------------------- -----------------------
2004 2003 2004 2003
---------------------- ----------------------
Prepaid benefits cost $ - $ - $ 762 $ 937
Accrued benefit cost (13,180) (11,488) (4,206) (4,182)
Additional minimum liability (8,928) (2,003) - -
Intangible assets 2,108 1,962 - -
Regulatory asset 4,140 41 - -
Accumulated other
comprehensive loss 2,680 - - -
---------------------- ----------------------
Net liability recognized $(13,180) $(11,488) $(3,444) $(3,245)
====================== ======================
48
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
At December 31, 2004 and 2003, the Company's pension plans had benefit
obligations in excess of its plan assets. The following tables provide the
projected benefit obligation, the accumulated benefit obligation and fair market
value of the plan assets as of December, 31:
Projected Benefit
Obligation Exceeds
the Fair Value of
Plan Assets
-------------------------
2004 2003
-------------------------
Projected benefit obligation $ 171,076 $ 150,098
Fair value of plan assets 115,292 108,731
Accumulated Benefit
Obligation Exceeds
the Fair Value of
Plan Assets
-------------------------
2004 2003
-------------------------
Accumulated benefit obligation $ 136,851 $ 121,521
Fair value of plan assets 115,292 108,731
The following table provides the components of net periodic benefit
costs for the years ended December 31,:
Other
Pension Benefits Postretirement Benefits
------------------------------ ------------------------------
2004 2003 2002 2004 2003 2002
------------------------------ ------------------------------
Service cost $ 4,312 $ 3,627 $ 3,205 $ 1,112 $ 987 $ 840
Interest cost 9,512 8,999 8,501 1,825 1,703 1,620
Expected return on plan assets (9,169) (7,775) (9,945) (1,086) (917) (953)
Amortization of transition
obligation (asset) (209) (209) (209) 803 803 803
Amortization of prior service cost 419 395 414 (57) (57) (57)
Amortization of actuarial (gain) loss 1,009 1,282 (2) 125 62 (5)
Amortization of regulatory asset - - - 144 136 136
Capitalized costs (1,021) (205) (66) (629) (598) (520)
------------------------------ ------------------------------
Net periodic benefit cost $ 4,853 $ 6,114 $ 1,898 $ 2,237 $ 2,119 $ 1,864
============================== ==============================
Accounting for pensions and other postretirement benefits requires 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. Each assumption is reviewed
annually with assistance from the Company's actuarial consultant who provides
guidance in establishing the assumptions. 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.
49
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
The significant assumptions related to the Company's pension and other
postretirement benefit plans are as follows:
Other
Pension Benefits Postretirement Benefits
----------------------- -----------------------
2004 2003 2004 2003
-------- -------- -------- --------
Weighted-average Assumptions Used
to Determine Benefit Obligations
as of December 31,
Discount rate 5.75% 6.25% 5.75% 6.25%
Rate of compensation increase 4.0-5.0% 4.0-5.0% 4.0% 4.0%
Assumed Health Care Cost Trend
Rates Used to Determine Benefit
Obligations as of December 31,
Health care cost trend rate n/a n/a 10% 10%
Rate to which the cost trend is assumed
to decline (the ultimate trend rate) n/a n/a 5% 5%
Year that the rate reaches the ultimate
trend rate n/a n/a 2010 2009
Weighted-average Assumptions Used
to Determine Net Periodic Benefit
Costs for Years Ended December 31,
Discount rate 6.25% 6.75% 6.25% 6.75%
Expected return on plan assets 8.50% 8.50% 6.0-9.0% 6.0-9.0%
Rate of compensation increase 4.0-5.0% 4.0-5.0% 4.0% 4.0%
Assumed Health Care Cost Trend
Rates Used to Determine Net Periodic
Benefit Costs for Years Ended December 31,
Health care cost trend rate n/a n/a 10% 10%
Rate to which the cost trend is assumed
to decline (the ultimate trend rate) n/a n/a 5% 5%
Year that the rate reaches the ultimate
trend rate n/a n/a 2009 2006
n/a - Assumption is not applicable to pension benefits.
Assumed health-care trend rates have a significant effect on the
expense and liabilities for other postretirement benefit plans. The health care
trend rate is based on historical rates and expected market conditions. A
one-percentage point change in the expected health-care cost trend rates would
have the following effects:
1-Percentage- 1-Percentage-
Point Point
Increase Decrease
------------- -------------
Effect on the health-care component of the
accrued other postretirement benefit
obligation $ 863 $ (910)
======= =======
Effect on total service and interest cost
components of net periodic postretirement
health-care benefit cost $ 92 $ (102)
======= =======
50
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
The discount rate is based on a market rate for a recognized-rating
agency's high-quality long-term bond portfolio with durations matching the
expected payouts under our retirement plans. The Company's pension expense and
liability (benefit obligations) increases as the discount rate is reduced.
The Company's expected return on assets is determined by evaluating the
asset class return expectations with its advisors as well as actual, long-term,
historical results of our asset returns. The Company's pension expense increases
as the expected return on assets decreases. The Company believes its actual
long-term asset allocation on average will approximate the targeted allocation.
The Company's investment strategy is to earn a reasonable rate of return while
maintaining risk at acceptable levels through the diversification of investments
across and within various asset categories. Investment returns are compared to
benchmarks that include the S&P 500 Index, the Lehman Brothers Intermediate
Government/Credit Index, and a combination of the two indices. The Pension
Committee meets semi-annually to review plan investments and management monitors
investment performance quarterly through a performance report prepared by an
external consulting firm.
The Company's pension plan asset allocation and the target allocation
by asset category are as follows:
Percentage of Plan
2005 Assets at December 31,
Target ------------------------------
Allocation 2004 2003
----------- ---------- ---------
Asset Category:
Equity securities 65% 62% 66%
Debt securities 35% 27% 32%
Cash 0% 11% 2%
-------- ---------- ---------
Total 100% 100% 100%
======== ========== =========
Equity securities include Aqua America, Inc. common stock in the
amounts of $7,373 or 6.4% of total plan assets and $6,469 or 5.9% of total plan
assets as of December 31, 2004 and 2003, respectively.
The asset allocation for the Company's other postretirement benefit
plans and the target allocation by asset category are as follows:
Percentage of Plan
2005 Assets at December 31,
Target ------------------------------
Allocation 2004 2003
----------- ---------- ---------
Asset Category:
Cash 65% 60% 64%
Equity securities 35% 40% 36%
-------- ---------- ---------
Total 100% 100% 100%
======== ========== =========
Minimum funding requirements for qualified defined benefit pension
plans are determined by government regulations and not by accounting
pronouncements. In accordance with funding rules and the Company's funding
policy, during 2005 our pension contribution is expected to be $7,278. The
Company's funding of its PBOP cost during 2005 is expected to approximate
$2,804.
As of December 31, 2004, the Company has an additional minimum
liability of $6,820 associated with our defined benefit plan. The additional
minimum liability is a result of the accumulated benefit obligation exceeding
the fair value of plan assets. The portion of the additional minimum liability
related to our employees in one of our rate jurisdictions results in the
establishment of a regulatory asset of $4,140, as the Company expects recovery
of the future, increased pension expense through customer rates. Since the
balance of the additional minimum liability of $2,680 may not be recovered
through rates, the accounting requirements for recording a regulatory asset are
not met and as a result this amount is recorded as an other comprehensive loss
for 2004 through a charge to accumulated other comprehensive income, net of
income tax benefits of $938. The change in the additional minimum liability from
December 31, 2003 to December 31, 2004 resulted from the effect of a decreased
discount rate, offset partially by an increase in the pension plan assets during
2004 due to positive equity market performance and pension contributions.
51
AQUA AMERICA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands of dollars, except per share amounts)
The Company has 401(k) savings plans that cover substantially all
employees. The Company makes matching contributions that are invested in Aqua
America, Inc. common stock based on a percentage of an employee's contribution,
subject to certain limitations. The Company's matching contribution, recorded as
compensation expense, was $1,160, $921 and $859 for the years ended December 31,
2004, 2003 and 2002, respectively.
Water and Wastewater Rates
On August 5, 2004, the Pennsylvania Public Utility Commission ("PAPUC")
granted Aqua Pennsylvania, Inc. a $13,800 base rate increase. The rates in
effect at the time of the filing included $11,200 in Distribution System
Improvement Charges ("DSIC") or 5.0% above the prior base rates. Consequently,
the total base rates increased by $25,000 and the DSIC was reset to zero. On
August 1, 2002, the PAPUC granted Aqua Pennsylvania, Inc. a $21,226 or 10.2%
base rate increase. The rates in effect at the time of the filing included
$9,400 in DSIC at 5.0%. Consequently, the total base rates increased by $30,626
and the DSIC was reset to zero.
In May 2004, the Company's operating subsidiary in Texas filed an
application with the Texas Commission on Environmental Quality to increase rates
by $11,920 over a multi-year period. The application seeks to increase annual
revenues in phases and is accompanied by a plan to defer and amortize a portion
of the Company's depreciation, operating and other tax expense over a similar
multi-year period, such that the annual impact on operating income approximates
the requested amount. The application is currently pending before the
Commission. The Company commenced billing for the requested rates and
implemented the deferral plan in August 2004, in accordance with authorization
from the Texas Commission on Environmental Quality in July 2004. The additional
revenue billed and collected prior to the final ruling are subject to refund
based on the outcome of the ruling. The revenue recognized and the expenses
deferred by the Company reflect an estimate of the final outcome of the ruling.
The Company's other operating subsidiaries were allowed annual rate
increases of $6,673 in 2004, $1,275 in 2003 and $3,024 in 2002, represented by
fourteen, eight and thirteen rate decisions, respectively. Revenues from these
increases realized in the year of grant were approximately $3,995, $839 and
$1,403 in 2004, 2003 and 2002, respectively.
Four states in which the Company operates permit water utilities, and
in some states wastewater utilities, to add a surcharge to their water or
wastewater bills to offset the additional depreciation and capital costs related
to infrastructure system replacement and rehabilitation projects completed and
placed into service between base rate filings. Currently, Pennsylvania,
Illinois, Ohio and Indiana allow for the use of infrastructure rehabilitation
surcharges. These mechanisms typically adjust periodically based on additional
qualified capital expenditures completed or anticipated in a future period. The
infrastructure rehabilitation surcharge is capped as a percentage of base rates,
generally 5% of base rates, and is reset to zero when new base rates that
reflect the costs of those additions become effective or when a utility's
earnings exceed a regulatory benchmark. Infrastructure rehabilitation surcharges
provided revenues in 2004, 2003 and 2002 of $7,817, $8,147 and $5,518,
respectively.
52
Selected Quarterly Financial Data (Unaudited) Aqua America, Inc. and Subsidiaries
(in thousands of dollars, except per share amounts)
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
---------------------------------------------------------------
2004
- -----------------------------------------------------------------------------------------------------------------
Operating revenues $ 99,768 $ 106,524 $ 120,305 $ 115,442 $ 442,039
Operations and maintenance expense 41,831 44,483 46,526 45,505 178,345
Operating income 36,444 40,473 50,997 49,320 177,234
Net income available to common
stock 15,575 17,871 24,087 22,474 80,007
Basic net income per common share 0.17 0.19 0.26 0.24 0.86
Diluted net income per common share 0.17 0.19 0.26 0.24 0.85
Dividend paid per common share 0.12 0.12 0.12 0.13 0.49
Dividend declared per common share 0.12 0.12 0.25 - 0.49
Price range of common stock
- high 22.85 21.96 22.22 24.64 24.64
- low 20.00 18.98 18.90 20.77 18.90
2003
- -----------------------------------------------------------------------------------------------------------------
Operating revenues $ 80,489 $ 83,379 $ 102,153 $ 101,212 $ 367,233
Operations and maintenance expense 30,664 31,029 36,777 42,132 140,602
Operating income 32,446 35,290 46,302 39,523 153,561
Net income available to common
stock 13,324 15,235 23,620 18,606 70,785
Basic net income per common share 0.16 0.18 0.26 0.20 0.80
Diluted net income per common share 0.16 0.18 0.26 0.20 0.79
Dividend paid per common share 0.112 0.112 0.112 0.120 0.456
Dividend declared per common share 0.112 0.112 0.232 - 0.456
Price range of common stock
- high 17.83 19.85 20.07 22.40 22.40
- low 15.77 17.22 18.28 18.71 15.77
High and low prices of the Company's common stock are as reported on
the New York Stock Exchange Composite Tape. The cash dividends paid in December
2004 of $0.13 and December 2003 of $0.12 were declared in August 2004 and August
2003, respectively.
Beginning August 1, 2003, the financial results for the operations
acquired in the AquaSource acquisition have been included in the Company's
consolidated financial statements.
53
Summary of Selected Financial Data Aqua America, Inc. and Subsidiaries
(in thousands of dollars, except per share amounts)
- ---------------------------------------------------------------------------------------------------------------------------
Years ended December 31, 2004 2003 (a) 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE:
Net income
Basic $ 0.86 0.80 0.78 0.71 0.65
Diluted 0.85 0.79 0.78 0.70 0.65
Cash dividends declared and paid 0.49 0.46 0.43 0.40 0.38
Return on average stockholders' equity 11.4% 12.3% 13.9% 13.3% 13.2%
Book value at year end $ 7.83 $ 7.11 $ 5.80 $ 5.52 $ 5.10
Market value at year end 24.59 22.10 16.48 18.04 15.68
- ---------------------------------------------------------------------------------------------------------------------------
INCOME STATEMENT HIGHLIGHTS:
Operating revenues $ 442,039 $ 367,233 $ 322,028 $ 307,280 $ 274,014
Depreciation and amortization 58,864 51,463 44,322 40,168 34,100
Interest expense, net (b) 46,375 42,535 39,007 38,637 37,775
Income before income taxes 132,131 116,718 109,252 99,087 86,995
Provision for income taxes 52,124 45,923 42,046 38,976 34,105
Net income available to common stock 80,007 70,785 67,154 60,005 52,784
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET HIGHLIGHTS:
Total assets $2,340,248 $2,069,736 $1,717,069 $1,555,108 $1,413,723
Property, plant and equipment, net 2,069,812 1,824,291 1,486,703 1,364,282 1,249,652
Stockholders' equity 748,468 659,030 493,097 472,717 430,587
Long-term debt, including current portion 834,656 736,052 617,175 531,455 472,712
Total debt 919,771 832,511 732,288 641,123 573,706
- ---------------------------------------------------------------------------------------------------------------------------
ADDITIONAL INFORMATION:
Net cash flows from operating activities $ 173,603 $ 143,373 $ 121,560 $ 102,165 $ 86,972
Capital additions 195,736 163,320 136,164 124,088 129,740
Net cash expended for acquisitions
of utility systems 54,300 192,331 8,914 9,517 3,546
Dividends on common stock 45,807 39,917 36,789 34,234 30,406
Number of customers served 835,512 749,491 605,474 587,537 565,146
Number of shareholders of common stock 24,082 22,726 21,389 20,920 20,978
Common shares outstanding (000) 95,385 92,589 84,896 85,483 83,869
Employees (full-time) 1,442 1,260 971 951 943
- ---------------------------------------------------------------------------------------------------------------------------
(a) Beginning August 1, 2003, the financial results for the operations acquired
in the AquaSource acquisition have been included in Aqua America's
consolidated financial statements.
(b) Includes dividends on preferred stock of subsidiary and minority interest,
net of allowance for funds used during construction.
54