EXHIBIT 13.5
SELECTED PORTION OF ANNUAL REPORT TO SHAREHOLDERS
FOR THE YEAR ENDED DECEMBER 31, 1997
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(In thousands of dollars, except per share amounts)
This report contains, in addition to historical information,
forward-looking statements that involve risks and uncertainties. These
forward-looking statements include statements regarding the Company's
development, growth and expansion plans and the sufficiency of the Company's
liquidity and capital. These statements are based on assumptions made by
management regarding future circumstances over which the Company may have little
or no control. Actual results may differ materially from these forward-looking
statements for a number of reasons, including (i) the effects of regulation,
(ii) changes in capital requirements and funding, and (iii) acquisitions.
Following are selected five-year financial statistics for the Company:
Years ended December 31, 1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------------------------------
Earned revenues $136,171 $122,503 $117,044 $108,636 $101,244
- --------------------------------------------------------------------------------------------------------------
Income from continuing operations
before income taxes $ 39,061 $ 33,749 $ 30,931 $ 27,209 $ 24,261
- --------------------------------------------------------------------------------------------------------------
Operating Statistics
Earned revenues 100.0% 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Operating expenses 41.1% 42.1% 44.2% 46.3% 45.4%
Depreciation and amortization 10.7% 10.9% 9.9% 9.5% 10.8%
Taxes other than income taxes 6.5% 6.8% 6.6% 6.6% 6.8%
Interest expense* 13.4% 12.9% 13.2% 12.7% 13.8%
Allowance for funds used during
construction (0.4)% (0.2)% (0.3)% (0.1)% (0.8)%
- --------------------------------------------------------------------------------------------------------------
Total costs and expenses 71.3% 72.5% 73.6% 75.0% 76.0%
- --------------------------------------------------------------------------------------------------------------
Income from continuing operations
before income taxes 28.7% 27.5% 26.4% 25.0% 24.0%
==============================================================================================================
Effective tax rates 40.6% 41.4% 41.7% 42.5% 43.0%
==============================================================================================================
Income from continuing operations
as a percentage of average
stockholders' equity 12.4% 11.7% 12.0% 11.2% 11.4%
==============================================================================================================
*Includes dividends on preferred stock of PSW with mandatory redemption
requirements.
Following are selected five-year operating and sales statistics for PSW:
Years ended December 31, 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------
Daily sendout
(Million gallons Maximum 142.5 109.5 121.8 110.4 120.7
per day) Average 103.8 94.2 92.6 89.8 89.1
====================================================================================
Metered Residential 268,550 265,746 248,500 234,624 232,684
customers Commercial 13,512 13,422 12,019 11,071 11,014
Industrial 708 716 554 539 538
Other 4,746 4,257 3,792 3,299 2,959
------------------------------------------------------------------------------------
Total 287,516 284,141 264,865 249,533 247,195
Consumption ====================================================================================
per customer
in gallons Average 110,143 103,206 109,084 109,001 110,368
====================================================================================
Revenues from Residential $ 88,542 $ 79,056 $ 77,744 $ 69,483 $ 66,656
water sales Commercial 28,048 26,504 24,368 23,431 20,506
Industrial 5,170 4,823 4,512 4,737 4,207
Other 10,874 9,950 9,249 9,151 8,092
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Total $ 132,634 $ 120,333 $ 115,873 $ 106,802 $ 99,461
====================================================================================
General Information
Philadelphia Suburban Corporation ("PSC" or the "Company"), a
Pennsylvania corporation, is the holding company of Philadelphia Suburban Water
Company ("PSW"), a regulated water utility. PSW provides water service to
approximately 288,000 customers in 93 municipalities within its 464 square mile
service territory. In addition, PSW provides water service to approximately
6,000 customers through an operating and maintenance contract to a municipal
authority located contiguous to its service territory. PSW's service territory
is located in Pennsylvania, north and west of the City of Philadelphia.
Results of Operations
Income from continuing operations of the Company has grown at an annual
compound rate of approximately 16.9% during the five-year period ended December
31, 1997. During this same period, revenues and total expenses, other than
income taxes, have grown at compound rates of 7.9% and 5.4%, respectively.
Earned Revenues
The growth in revenues over the past five years is a result of
increases in the customer base and in water rates. The number of customers
increased at an annual compound rate of 3.3% in the past five years primarily as
a result of acquisitions of local water systems. Acquisitions made during the
five year periods ended December 31, 1997, 1996 and 1995 have provided water
revenues of approximately $11,460, $8,210 and $5,550 in 1997, 1996 and 1995,
respectively. Excluding the effect of acquisitions, the customer base increased
at a five-year annual compound rate of .8%. Water rates have increased at an
annual compound growth rate of 4.5% over the five-year period.
Rates charged by PSW for water service are subject to the approval of
the Pennsylvania Public Utility Commission ("PUC"). PSW continuously reviews the
necessity of filing applications with the PUC for increases in rates charged for
water service. Among the factors considered by management in determining the
need to apply for increased rates are: the amount of utility plant additions and
replacements made since the previous rate decision; changes in the cost of
capital and the capital structure of PSW; and increases in operating expenses
(including wages, fringe benefits, electric and chemical expenses), depreciation
and taxes experienced since the previous rate decision. Based on these
assessments, PSW periodically files requests with the PUC to increase its rates.
Typically, the PUC will suspend the rate request for up to nine months during
which time evidentiary hearings on the merits of the request are held. The
positions of PSW as well as the PUC staff, the Office of Consumer Advocate
("OCA") and other interested parties are presented and evaluated during these
hearings.
In 1996, the PUC approved a mechanism, the Distribution System
Improvement Charge ("DSIC"), which allows Pennsylvania water utilities to add a
surcharge to their water bills to offset the additional depreciation and capital
costs associated with certain non-revenue producing, non-expense reducing
capital expenditures related to replacing and rehabilitating distribution
systems. The DSIC mechanism is intended to eliminate many of the disincentives
faced by water utilities in rehabilitating their distribution systems. These
disincentives, often referred to as regulatory lag, are due to the rate making
process which, prior to the establishment of the DSIC mechanism, required water
utilities to absorb all of the depreciation and capital costs of these projects
between base rate increases without the benefit of additional revenues.
The DSIC may be adjusted quarterly based on additional qualified
capital expenditures made in the previous quarter but may never exceed 5% of the
base rates in effect. The DSIC is reset to zero when new base rates that reflect
the costs of those additions become effective. PSW began charging a DSIC of .5%
in the first quarter of 1997. Based on subsequent qualified capital expenditures
the DSIC was increased to 1.0% in the second quarter, 1.4% in the third quarter
and 1.82% for the portion of the fourth quarter prior to the effective date of
the new base rate increase. Total revenues associated with the DSIC in 1997 were
$1,104.
In April 1997, PSW filed an application with the PUC to increase its
rates by 13.2%. The request was suspended to allow the PUC Staff, the OCA and
other interested parties a period of additional discovery and to hold hearings
on the merits of this request. Prior to the commencement of hearings, PSW
reached a settlement with the OCA and the other interested parties. The
settlement, which was subsequently approved by the PUC, provided for a 7.3%
increase over the rates that were in effect at the time of the filing. Since
rates in effect at the time of the filing included a DSIC of 1% or $1,300 on an
annual basis, the settlement resulted in a total base rate increase of 8.3% or
$10,600 on an annual basis. The new base rates were effective on October 24,
1997. As part of the settlement, PSW has agreed not to file its next base rate
increase request prior to April 1999, absent extraordinary circumstances. As a
result of the rate settlement, the DSIC was reset to zero.
In the years prior to 1997, rates were increased 5.3%, 9.1% and 7.4% in
1995, 1994, and 1993, respectively. In recent years, the most significant factor
in determining the need for a rate increase and the actual rate increases
granted has been the amount of utility plant additions that PSW has made,
including acquisitions, and the costs of the capital used to finance these
additions.
In addition to increases in base rates, the PUC has adjusted rates by
means of a surcharge or credit to reflect changes in the tax laws, which were
not reflected in the base rates approved by the PUC. These adjustments are
eliminated when the tax changes are reflected in base rates. During 1995 and
1994, rates were reduced by various credits as a result of reductions in
Pennsylvania taxes. These credits resulted in revenue reductions of $504 in 1995
and $97 in 1994.
"Sendout" represents the quantity of treated water delivered to the
distribution system and is used by management as an indicator of customer
demand. Consumption per customer is the sendout that was used by metered
customers and is based on the actual bills rendered during the year adjusted for
the estimated unbilled customer usage. Water consumption tends to be impacted by
weather conditions, particularly 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. It is difficult to establish an exact correlation between the
weather and water consumption, since conservation and even day-to-day variations
in weather patterns can have a significant effect. 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 may
have an effect on water consumption.
Over the past five years, sendout has increased primarily as a result
of PSW's growth in customers. The average annual consumption per customer
increased in 1997 by 6.7% and declined by 5.4% in 1996 but has only varied
slightly in the previous three years. The increase in the average consumption
per customer in 1997 is attributable to the relatively hot, dry summer weather
experienced in 1997, particularly in comparison to 1996 when average consumption
per customer declined due to rainfalls that were well above average and
temperatures that were cooler than normal during the spring and summer months.
Operating Expenses
Operating expenses for 1997, 1996 and 1995, totaled $55,899, $51,615
and $51,702, respectively. Most elements of operating expense are subject to the
effects of inflation, as well as the effects of changes in the number of
customers served, in water consumption and the degree of treatment required due
to variations in the quality of the raw water. The principal elements of
operating costs are labor, electricity, chemicals and maintenance expenses.
Electricity and chemical expenses vary in relationship to water consumption and
raw water quality. Maintenance expenses are sensitive to extreme cold weather,
which can cause water mains to rupture.
Operating expenses increased in 1997 over 1996 by $4,284 or 8.3%
primarily as a result of the operating expenses of the water systems acquired in
1997 and 1996 of $1,883, higher production costs resulting from the increased
volume of water sold of $740, and increased wage and administrative expenses,
partially offset by lower maintenance expenses. Administrative costs increased
as a result of increases in insurance costs, and in the bad debt reserve which
is related to the increase in revenues. Maintenance expenses declined due to
fewer main breaks as a result of the effects of the relatively mild 1997 winter.
Operating expenses decreased slightly in 1996 over 1995 primarily as a
result of reductions in pension, employee medical insurance premiums and general
liability insurance costs offset in part by the additional operating expenses
associated with the acquisitions made in 1996 and 1995. Pension expense declined
as a result of the investment returns in the previous two years on the pension
assets. Medical insurance costs declined as a result of favorable claims
experience with the carriers and the movement of a majority of employees from
indemnity health plans to managed care plans.
For the past three years, corporate costs were less than 1% of the
Company's operating expenses. Such expenses include those unallocated general
and administrative expenses associated with maintaining a publicly-held company.
Depreciation and Amortization
Depreciation expense was $14,311, $13,068 and $11,572 in 1997, 1996 and
1995, respectively, and has increased principally as a result of the significant
capital expenditures made to expand and improve the water utility facilities,
and as a result of acquisitions of water systems. Depreciation expense was
approximately 2.3% of the average utility plant in service for 1997 and 1996,
respectively. Amortization was a charge of $269 in 1997, $265 in 1996 and a
credit of $15 in 1995. The increase in 1997 is due to the amortization of
additional debt issuance expenses and amortization of the costs of PSW's 1997
rate filing, offset in part by the completion of amortization of the costs of
PSW's 1995 rate filing. Expenses associated with filing rate cases are deferred
and amortized over approximately 18 months. The increase in 1996 over 1995 is
due to the amortization of the costs of PSW's 1995 rate filing as well as the
amortization of additional debt issuance expenses.
Taxes Other than Income Taxes
Taxes other than income taxes increased by approximately 8% in both
1997 and 1996 over the previous year. The majority of the increase in both years
is associated with increases in the base on which the Pennsylvania Public
Utility Realty Tax (PURTA), local real estate taxes and the Capital Stock Tax
are calculated and to an increase in the PURTA tax rate. The increase in the
taxable base for the PURTA and local real estate taxes is due to the capital
expenditures, and the acquisitions completed in the last three years. The
increase in the Capital Stock Tax is due to the increases in the Company's
common equity over the past three years.
Interest Expense
Interest expense was $17,890, $15,311, and $14,852 in 1997, 1996 and
1995, respectively, and has increased in 1997 and 1996 primarily as a result of
higher levels of borrowing offset in part by a reduction in interest rates. The
level of debt increased in order to finance acquisitions and other capital
expenditures made since 1995.
Allowance for Funds Used During Construction
The allowance for funds used during construction ("AFUDC") was $522,
$264 and $305 in 1997, 1996 and 1995, respectively, 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 average balance of CWIP to which AFUDC is applied was $8,641,
$4,441 and $4,848 in 1997, 1996 and 1995, respectively. The increase in 1997 in
the average balance of CWIP was due to the increased level of capital
expenditures in 1997 as compared to 1996. The decrease in 1996 is due to a
$4,945 operations center that was under construction during 1995 and placed in
service in December 1995. AFUDC is not applied to projects after they are placed
in service, but is applied to an ever-increasing base during the period they are
under construction.
The AFUDC rate has varied due to changes in the interest rate on PSW's
revolving credit facility. The average AFUDC rate was 6.1%, 6.1% and 6.3% in
1997, 1996 and 1995, respectively.
Income Taxes
The Company's effective income tax rate was 40.6% in 1997 as compared
to 41.4% in 1996 and 41.7% in 1995. The changes in the effective tax rates in
1997 and 1996 are due to differences between tax deductible expenses and book
expenses.
Discontinued Operations
In 1993, the Company completed the sale of the last of the nonregulated
businesses that the Board of Directors authorized in 1990 and 1991. These
businesses are accounted for as discontinued operations. In connection with the
decision to sell these businesses, the Company established reserves to cover
future costs and contingencies that the Company could be required to pay.
In 1996 and 1995, the Company reversed $965 and $370, net of related
income taxes, of the reserves. The reversals were made as a result of: the
receipt of contingent sales proceeds from two of the businesses that were sold;
the passage of time, which reduced certain potential lease obligations; and the
assessment of current information on asserted and unasserted legal claims
related to these businesses. In 1997, the Company received additional sale
proceeds of $250 from one of the businesses sold and included the amount in
Earned Revenues. The balance of the reserves for discontinued operations of
$1,009 at December 31, 1997 consists primarily of reserves for future and
contingent costs including potential lease, legal and insurance costs associated
with these businesses.
Summary
Operating income in 1997, 1996 and 1995 was $56,799, $49,290 and
$46,109, respectively, and income from continuing operations was $23,188,
$19,778 and $18,030, respectively, for the same periods. Diluted income per
share from continuing operations in 1997, 1996 and 1995 was $.88, $.78 and $.75,
respectively. The increases in the per share income in 1997 and 1996 over the
previous years were due to the aforementioned improvements in profits offset in
part by a 4.0% and 5.6% increase in the average number of common shares
outstanding during 1997 and 1996, respectively.
Although the Company has 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 for the fourth quarter of 1997
increased over the same period in 1996 by $171 to $5,432 primarily as a result
of a $3,382 increase in revenues offset in part by an increase in operating
expenses, depreciation, amortization, taxes other than income, interest expense
and preferred dividends, and to the absence, in 1997, of the reversal of
reserves for discontinued operations. The increase in revenues was primarily a
result of the acquisitions made during the past two years, the rate increase,
which took effect October 24, 1997 and an increase in water sales. Operating
expenses increased primarily due to costs associated with the acquisitions and
the increased water sales. Depreciation increased due to utility plant additions
and the acquisitions made since the fourth quarter of 1996. Amortization
increased due to the amortization of the costs associated with the 1997 rate
request filing. Taxes other than income taxes increased primarily because of the
increase in the base on which the PURTA and Capital Stock Tax are computed and
to an increase in the PURTA tax rate. Interest increased in the fourth quarter
primarily as a result of higher borrowing levels.
Effects of Inflation
As a regulated enterprise, PSW's rates are established to provide
recovery of costs and a return on its 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 PSW's operating results are not significant.
Year 2000
Except for its customer information system, the Company's management
information systems are year 2000 compliant in all material respects. The
Company is currently installing a new customer information system which, in
addition to being year 2000 compliant, will offer additional functionality and
will be scalable to meet future customer growth. The installation of the new
customer information system will be completed in 1998 and the cost of this
system, including installation and conversion from the existing system, is
currently estimated at approximately $3,140.
Electric Deregulation
During 1997, the total costs for electric power purchased by the
Company amounted to $8,575. In December 1996, the Governor of Pennsylvania
signed into law the Electricity Generation Customer Choice and Competition Act
("Electric Act") which provides for the restructuring of the electric utility
industry in Pennsylvania. The Electric Act requires the unbundling of electric
services into separate generation, transmission and distribution services with
open competition for generation. Beginning in November 1997, approximately 18%
of PSW's electricity requirements were selected to be included in the State's
pilot implementation program. Prior to the pilot program, PSW had purchased all
of its electricity from PECO Energy Company ("PECO"). For electric accounts in
the pilot program, the electricity will be purchased from HorizonOne Electric, a
PECO affiliate. The total electric costs for the twelve-month period prior to
the pilot program for the accounts selected were approximately $1,020. The
Company estimates that the electric rates during participation in the pilot
program will be approximately 10% to 12% lower than the former rates. Since
electric usage is dependent on water demand, the exact savings related to the
pilot program cannot be determined at this time. A recent ruling by the PUC
provides that after completion of the pilot program on December 31, 1998, 66% of
PECO's electric accounts, including the accounts in the pilot program and others
to be selected in a lottery, will be permitted to choose the electricity
generator of their choice. The Electric Act will be completely phased in on
January 1, 2001 at which point all electric accounts will be allowed to select
their electric supplier. The PUC ruling is subject to appeal by PECO and others.
Financial Condition
Cash Flow and Capital Expenditures
Net operating cash flow, dividends paid on common stock and capital
expenditures, including allowances for funds used during construction, for the
five years ended December 31, 1997 were as follows:
- --------------------------------------------------------------------------------
Net Operating Common Capital
Cash Flow Dividends Expenditures
- --------------------------------------------------------------------------------
1993 $ 27,049 $ 11,629 $ 27,958
1994 29,730 12,637 27,379
1995 32,954 13,546 33,182
1996 37,422 14,795 31,389
1997 41,843 16,129 38,960
- --------------------------------------------------------------------------------
$ 168,998 $ 68,736 $ 158,868
================================================================================
Included in capital expenditures are: $11,650 for the construction of a
surface water treatment plant; $15,189 for the modernization of existing
treatment plants; $20,084 for new water mains and customer service lines;
$30,101 for the rehabilitation of existing water mains; $9,835 to rehabilitate
hydrants and customer service lines; $19,238 for water meters and $4,945 for the
construction of a divisional operations center. During this five year period,
PSW received $7,702 of advances and contributions in aid of construction to
finance new water mains. In addition to its capital program, PSW has made
sinking fund contributions aggregating $3,536, retired $71,700 of debt and
$5,786 of preferred stock, and has refunded $9,639 of customer advances for
construction. PSW has also expended $71,634 related to the acquisition of 19
water systems and 2 small wastewater utilities since 1993.
Since net operating cash flow to PSW plus advances and contributions in
aid of construction have not been sufficient to fully fund its cash
requirements, PSW issued approximately $141,000 of First Mortgage Bonds, and
received $32,495 of equity investments from the Company during the past five
years.
The Company has funded its investment in PSW with the proceeds from the
sale of stock and the sale of its discontinued operations. In April 1993, the
Company sold 2,200,000 shares of common stock in a public offering for net
proceeds of $18,331. The Company has also sold 3,901,636 original issue shares
of common stock for net proceeds of $41,423 since 1993 through three programs
that allowed existing shareholders and customers of PSW to purchase shares of
common stock directly from the Company as described in the following table:
Customer Optional
Stock Dividend Stock
Purchase Reinvestment Purchase
Program Program Program Total
- -------------------------------------------------------------------------------------------
Net proceeds:
1993 $ 5,465 $ 1,491 $ 583 $ 7,539
1994 3,541 2,047 603 6,191
1995 4,680 2,324 842 7,846
1996 7,953 3,111 1,216 12,280
1997 3,122 3,650 795 7,567
- ------------------------------------------------------------------------------------------
$24,761 $ 12,623 $ 4,039 $ 41,423
==========================================================================================
Shares issued:
1993 597,880 173,408 63,715 835,003
1994 401,380 234,040 66,216 701,636
1995 510,911 265,820 91,337 868,068
1996 644,151 266,129 97,353 1,007,633
1997 201,092 237,437 50,767 489,296
- ------------------------------------------------------------------------------------------
2,355,414 1,176,834 369,388 3,901,636
==========================================================================================
In December 1997, the Company adopted a Dividend Reinvestment and
Direct Stock Purchase Plan ("Plan") that replaced the Customer Stock Purchase
Plan and the Dividend Reinvestment and Optional Stock Purchase Plan. Under the
direct stock purchase portion of the Plan, shares are sold throughout the year,
instead of during quarterly subscription periods, and the shares are obtained by
the Company's transfer agent in the open market instead of original issue shares
of stock. The dividend reinvestment portion of the Plan continues to offer a 5%
discount on the purchase of original issue shares of common stock with
reinvested dividends. As of the December 1997 dividend payment, holders of 23%
of the common shares outstanding participated in the dividend reinvestment
portion of the Plan.
In August 1997, the Board of Directors approved a resolution
authorizing the Company to purchase 500,000 shares of its common stock in the
open market or through privately negotiated transactions. A similar resolution
was approved in 1993. Management has used this authority, from time to time, to
offset the dilutive effect on earnings per share resulting from the original
issue shares issued through the plans previously discussed. During 1997, 1996
and 1995, the Company purchased 152,000, 4,339 and 78,912 shares at a net cost
of $2,284, $52 and $733, respectively. (For comparative purposes, the numbers of
shares in the previous sentence have been adjusted to give effect to the 1997
4-for-3 common stock split in the form of a stock distribution). As of December
31, 1997, the remaining number of shares the Company may purchase under the
Board of Director's authorization is 628,145. Funding for future stock
purchases, if any, is not expected to have a material impact on the Company's
financial position.
PSW's planned 1998 capital program, exclusive of the costs of new mains
financed by advances and contributions in aid of construction, is estimated to
be $55,000 of which $33,400 is for DSIC qualified projects. PSW has increased
its capital spending for infrastructure rehabilitation in response to the DSIC.
Should the DSIC be discontinued for any reason, which is not anticipated, PSW
would likely reduce its capital program significantly. The 1998 capital program,
along with the January 1998 acquisition of the water utility assets of the West
Chester Area Municipal Authority, $2,448 of sinking fund obligations and $4,214
of preferred stock redemptions is expected to be financed through
internally-generated funds, the revolving credit facility, equity investments
from the Company, and issuance of new long-term debt.
In January 1998, the Company registered 1,100,000 of shares of common
stock for sale in a public offering that it expects to complete in February
1998. Based on the market price of the Company's common stock in late January
1998, the Company anticipates proceeds of $25,239, net of expenses, from this
offering, $28,706 if the underwriters' option to sell an additional 150,000
shares is exercised. The proceeds of this offering will be used to make a
$19,000 equity contribution to PSW and to repay short-term debt.
PSW continues to hold acquisition discussions with several water
systems that are near or adjacent to PSW's service territory. The cash needed
for acquisitions is expected to be funded initially with short-term debt with
subsequent repayment from the proceeds of long-term debt or equity investments
from the Company.
Future utility construction in the period 1999 through 2002, including
recurring programs, such as the ongoing replacement of water meters, 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 $200,000, the majority of which will be DSIC
qualified projects to rehabilitate the distribution system. The Company
anticipates that approximately 50% of these expenditures will require external
financing including the additional issuance of Common Stock through the
Company's dividend reinvestment plan and possible future public equity
offerings. The Company expects to refinance $20,238 of 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.
PSW's ability to finance its future construction programs, as well as
its acquisition activities, depends on its ability to attract the necessary
external financing and maintain or increase internally-generated funds. Rate
orders permitting compensatory rates of return on invested capital and timely
rate adjustments will be required to allow PSW to achieve an adequate level of
earnings to enable it to secure the capital it will need and to maintain
satisfactory debt coverage ratios.
Capitalization
The following table summarizes PSC's capitalization during the past
five years:
December 31, 1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------
Long-term debt* 54.2% 55.3% 53.5% 49.9% 50.7%
Preferred stock * 1.7% 2.1% 2.0% 3.3% 3.4%
Common stockholders' equity 44.1% 42.6% 44.5% 46.8% 45.9%
- -----------------------------------------------------------------------------------------
100.0% 100.0% 100.0% 100.0% 100.0%
=========================================================================================
*includes current portion
The changes in the capitalization ratios result from the issuance of
common stock over the past five years, particularly in 1993, and the issuance of
debt by PSW to finance its acquisitions and capital program. It is the Company's
and PSW's goal to maintain an equity ratio adequate to support PSW's current
Standard and Poors debt rating of "A" and the expected issuance of common stock
in an underwritten public offering in February 1998 will increase its common
equity ratio.
Impact of Recent Accounting Pronouncements
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 128, "Earnings per Share"
("SFAS 128") which introduces new methods for calculating earnings per share.
The Company adopted this Statement, as required, in December 1997. The adoption
of this Statement required the Company to restate earnings per share reported in
prior periods.
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. The Company plans to adopt this Statement on January 1, 1998, as
required.
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" ("SFAS 131"). This Statement established standards for reporting
information about operating segments in annual financial statements and requires
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosure
about products and services, geographic areas and major customers. The Company
plans to adopt this statement on January 1, 1998, as required. The adoption of
this Statement will not affect results from operations, financial conditions or
long-term liquidity.
Dividends on Common Stock
Following is a recent history, adjusted for the 1997 4-for-3 common
stock split in the form of a stock distribution, of the Company's income from
continuing operations and dividends:
- --------------------------------------------------------------------------------
Basic
income per
share from Dividend
Cash dividend continuing payout
per common share operations ratio
- --------------------------------------------------------------------------------
1993 $0.54 $0.64 84%
1994 0.55 0.68 81%
1995 0.57 0.75 76%
1996 0.59 0.79 75%
1997 0.62 0.89 70%
- --------------------------------------------------------------------------------
Dividends have averaged approximately 77% of income from continuing
operations during this period. During 1997, the Board of Directors increased the
dividend rate by 7%. As a result, beginning with the dividend payable in March
1998, the annual dividend rate increased to $.65 per share.
MANAGEMENT'S REPORT
The consolidated financial statements and related information for the
years ended December 31, 1997, 1996 and 1995 were prepared by management in
accordance with generally accepted accounting principles and include
management's best estimates and judgments, as required. Financial information
included in other sections of this annual report is consistent with that in the
consolidated financial statements.
The Company has an internal accounting control structure designed to
provide reasonable assurance that assets are safeguarded and that transactions
are properly authorized and recorded in accordance with established policies and
procedures. The internal control structure is supported by the selection and
training of qualified personnel, the delegation of management authority and
responsibility and dissemination of policies and procedures.
The Company's independent auditors, KPMG Peat Marwick LLP, provide an
independent review of management's reporting of results of operations and
financial condition. KPMG has audited the financial statements by conducting
tests as they deemed appropriate and their report follows.
The Board of Directors through the Audit Committee selects the
Company's independent auditors and reviews the scope and results of their
audits. The Audit Committee also reviews the adequacy of the Company's internal
control structure and other significant matters. The Audit Committee is
comprised of four outside Directors who meet periodically with management and
the independent auditors. The Audit Committee held two meetings in 1997.
Nicholas DeBenedictis Michael P. Graham
Chairman & Senior Vice President - Finance
President & Treasurer
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors
Philadelphia Suburban Corporation:
We have audited the accompanying consolidated balance sheets and
statements of capitalization of Philadelphia Suburban Corporation and
subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of income, and cash flow for each of the years in the three-year
period ended December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Philadelphia
Suburban Corporation and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997, in conformity with generally accepted
accounting principles.
KPMG PEAT MARWICK LLP
Philadelphia, Pennsylvania
January 28, 1998
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
Years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
Earned revenues $136,171 $122,503 $117,044
Costs and expenses:
Operating expenses 55,899 51,615 51,702
Depreciation 14,311 13,068 11,572
Amortization 269 265 (15)
Taxes other than income taxes 8,893 8,265 7,676
------- ------- -------
79,372 73,213 70,935
Operating income 56,799 49,290 46,109
Interest expense 17,890 15,311 14,852
Dividends on preferred stock of subsidiary 370 494 631
Allowance for funds used during construction (522) (264) (305)
------- ------- -------
Income from continuing operations before income
taxes 39,061 33,749 30,931
Provision for income taxes 15,873 13,971 12,901
------- ------- -------
Income from continuing operations 23,188 19,778 18,030
Reversal of reserve for discontinued operations,
net of income tax of $520 and $200, in
1996 and 1995 -- 965 370
------- ------- -------
Net income 23,188 20,743 18,400
Dividends on preferred stock 195 21 --
------- ------- -------
Net income available to common stock $ 22,993 $ 20,722 $ 18,400
======== ======== ========
Basic net income per common share:
Continuing operations $ 0.89 $ 0.79 $ 0.75
Discontinued operations -- 0.04 0.02
------- ------- -------
Total $ 0.89 $ 0.83 $ 0.77
======== ======== ========
Diluted net income per common share:
Continuing operations $ 0.88 $ 0.78 $ 0.75
Discontinued operations -- 0.04 0.02
------- ------- -------
Total $ 0.88 $ 0.82 $ 0.77
======== ======= =======
Average common shares outstanding during the period 25,908 24,966 23,803
======== ======= =======
See accompanying notes to consolidated financial statements.
1
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands of dollars, except per share amounts)
December 31, 1997 and 1996
1997 1996
---- ----
Assets
------
Property, plant and equipment, at cost $656,011 $612,812
Less accumulated depreciation 121,528 109,874
-------- --------
Net property, plant and equipment 534,483 502,938
Current assets:
Cash 680 1,518
Accounts receivable, net 23,534 21,914
Inventory, materials and supplies 1,847 1,943
Prepayments and other current assets 1,002 660
------- -------
Total curent assets 27,063 26,035
Regulatory assets 51,203 48,491
Deferred charges and other assets, net 5,723 5,480
------- --------
$618,472 $582,944
======== ========
Liabilities and Stockholders' Equity
------------------------------------
Stockholders' equity:
6.05% Series B cumulative preferred stock $ 3,220 $ 3,220
Common stock at $.50 par value, authorized
40,000,000 shares, outstanding 26,210,654
and 25,598,105 in 1997 and 1996 13,294 9,731
Capital in excess of par value 128,065 121,439
Retained earnings 56,136 49,272
Treasury stock, 376,510 and 262,230 shares
in 1997 and 1996 (5,970) (3,647)
------- -------
Total stockholders' equity 194,745 180,015
------- -------
Preferred stock of subsidiary with mandatory
redemption requirements -- 4,214
Long-term debt, excluding current portion 232,471 217,518
Commitments -- --
Current liabilities:
Current portion of long-term debt and preferred
stock of subsidiary 6,662 13,873
Loans payable 10,400 5,560
Accounts payable 10,259 9,659
Accrued interest 3,978 3,660
Accrued taxes 3,643 3,363
Other accrued liabilities 9,755 8,924
------- -------
Total current liabilities 44,697 45,039
------- -------
Deferred credits and other liabilities:
Deferred income taxes and investment tax credits 83,129 75,949
Customers' advances for construction 25,810 23,524
Other 12,764 12,826
------- -------
Total deferred credits and other liabilities 121,703 112,299
------- -------
Contributions in aid of construction 24,856 23,859
------- -------
$618,472 $582,944
======== =======
See accompanying notes to consolidated financial statements.
2
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CAPITALIZATION
(In thousands of dollars, except per share amounts)
December 31, 1997 and 1996
1997 1996
---- ----
Stockholders' equity:
6.05% Series B cumulative preferred stock $ 3,220 $ 3,220
Common stock, %.50 par value 13,294 9,731
Capital in excess of par value 128,065 121,439
Retained earnings 56,136 49,272
Treasury stock (5,970) (3,647)
------- -------
Total stockholders' equity 194,745 180,015
------- -------
Preferred stock of subsidiary with mandatory
redemption requirements 4,214 5,643
Current portion of preferred stock of subsidiary 4,214 1,429
------- -------
-- 4,214
------- -------
Long-term debt:
First Mortgage Bonds secured by utility plant:
8.44% Series, due 1997 -- 12,000
5.95% Series, due 2002* 2,000 2,400
6.30% Series, due 2002 10,000 --
6.83% Series, due 2003 10,000 10,000
7.47% Series, due 2003 10,000 10,000
7.06% Series, due 2004 10,000 --
6.82% Series, due 2005 10,000 10,000
6.99% Series, due 2006 10,000 10,000
6.75% Series, due 2007 10,000 --
9.89% Series, due 2008 5,000 5,000
7.15% Series, due 2008* 22,000 22,000
9.12% Series, due 2010 20,000 20,000
6.50% Series, due 2010* 3,200 3,200
9.17% Series, due 2011 5,000 5,000
9.93% Series, due 2013 5,000 5,000
6.89% Series, due 2015 12,000 12,000
9.97% Series, due 2018 5,000 5,000
9.17% Series, due 2021* 8,000 8,000
6.35% Series, due 2025 22,000 22,000
7.72% Series, due 2025 15,000 15,000
9.29% Series, due 2026 12,000 12,000
------- -------
Total First Mortgage Bonds 206,200 188,600
Note payable to bank under revolving credit
agreement, due March 1998 27,128 39,727
Installment note payable, 9%, due in equal annual
payments through 2013 1,591 1,635
------- -------
234,919 229,962
Current portion of long-term debt 2,448 12,444
------- -------
Long-term debt, excluding current portion 232,471 217,518
------- -------
Total capitalization $427,216 $401,747
======== =======
* Trust indentures relating to these First Mortgage Bonds require annual
sinking fund payments.
See accompanying notes to consolidated financial statements.
3
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED CASH FLOW STATEMENTS
(In thousands of dollars)
Years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Income from continuing operations $23,188 $19,778 $18,030
Adjustments to reconcile income from
continuing operations to net cash
flows from operating activities:
Depreciation and amortization 14,580 13,333 11,557
Deferred taxes, net of taxes on
customers' advances 3,797 2,628 2,573
Net increase in receivables,
inventory and prepayments (1,396) (517) (2,037)
Net increase in payables, accrued interest
and other accrued liabilities 2,354 1,748 4,604
Other (680) 452 (1,773)
------- ------- -------
Net cash flows from operating activities 41,843 37,422 32,954
------- ------- -------
Cash flows from investing activities:
Property, plant and equipment additions,
including allowance for funds used during
construction of $522, $264 and $305 (38,960) (31,389) (33,182)
Acquisitions of water and wastewater systems (1,226) (42,122) (26,351)
Other (535) 24 (91)
------- ------- -------
Net cash flows used in investing activities (40,721) (73,487) (59,624)
------- ------- -------
Cash flows from financing activites:
Customers' advances and contributions in aid of
construction 953 470 1,600
Repayments of customers' advances (2,408) (2,142) (2,104)
Net proceeds (repayments) of short-term debt 4,840 (895) 2,405
Proceeds from long-term debt 29,665 64,256 57,906
Repayments of long-term debt including
premium on early retirement (25,042) (24,094) (23,585)
Redemption of preferred stock of subsidiary (1,428) (1,500) (2,857)
Proceeds from issuing common stock 10,695 14,651 9,060
Repurchase of common stock (2,829) (760) (733)
Dividends paid on preferred stock (195) (4) --
Dividends paid on common stock (16,129) (14,795) (13,546)
Other (82) (167) (154)
------- ------- -------
Net cash flows from (used in) financing activities (1,960) 35,020 27,992
------- ------- -------
Net cash flows from (used in) discontinued operations -- 176 (178)
------- ------- -------
Net increase (decrease) in cash (838) (869) 1,144
Cash balance beginning of year 1,518 2,387 1,243
------- ------- -------
Cash balance end of year $ 680 $ 1,518 $ 2,387
======== ======= =======
See Acquisitions footnote for description of non-cash investing and financing
activities.
See accompanying notes to consolidated financial statements.
4
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
Summary of Significant Accounting Policies
Nature of Operations
The business of Philadelphia Suburban Corporation (the "Company") is
conducted primarily through its subsidiary Philadelphia Suburban Water Company
("PSW"). PSW is a regulated public utility which supplies water to approximately
288,000 customers. The customers are residential, commercial and industrial in
nature, and no single customer accounted for more than one percent of PSW's
sales. The service territory of PSW covers a 464 square mile area located west
and north of the City of Philadelphia. In addition, PSW provides water service
to approximately 6,000 customers through an operating and maintenance contract
with a municipal authority contiguous to its service territory. PSW is subject
to regulation by the Pennsylvania Public Utility Commission ("PUC") which has
jurisdiction with respect to rates, service, accounting procedures, issuance of
securities, acquisitions and other matters.
Consolidation
The consolidated financial statements include the accounts of the
Company and its subsidiaries, all of which are wholly-owned. All material
intercompany accounts and transactions have been eliminated.
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.
Non-utility revenues are recognized when services are performed.
Net Income per Common Share
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings per Share" in the fourth quarter of 1997. SFAS No.
128 requires the Company to use methods for calculating earnings per share that
differ from methods used in prior periods and requires the Company to restate
net income per share reported in prior periods. The adoption of this statement
had no effect on the results of operations, financial conditions, or long-term
liquidity.
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 depreciation, and the purchase price is
recorded as an acquisition adjustment within utility plant. At December 31,
1997, utility plant includes a credit acquisition adjustment of $6,719, which is
being amortized over 20 years. Consistent with PSW's rate settlements, $449 was
amortized during 1997, $526 was amortized during 1996 and $529 was amortized
during 1995.
Utility expenditures for maintenance and repairs, including minor
renewals and betterments, are charged to operating expenses in accordance with
the Uniform System of Accounts prescribed by the PUC. The cost of new units of
5
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
property and betterments are capitalized. 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.
The straight-line remaining life method is used to compute depreciation
on utility plant. The straight-line method is used with respect to
transportation and mechanical equipment, office equipment and laboratory
equipment.
In accordance with the requirements of SFAS No. 121, "Accounting for
the Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed
Of", the long-lived assets of the Company, which consist primarily of Utility
Plant in Service and a regulatory asset, have been reviewed for impairment.
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. 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. There was no AFUDC related to equity funds in any of the
years presented.
Deferred Charges and Other Assets
Deferred bond and preferred stock 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.
Expenses associated with filing for rate increases are deferred and
amortized over approximately 18 months. Other costs, for which PSW has received
or expects to receive prospective rate recovery, are deferred and amortized over
the period of rate recovery.
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
financial statements. These deferred income taxes are based on the enacted tax
rates expected to be in effect when such temporary differences are projected to
reverse.
Customers' Advances for Construction
Water mains or, in some instances, cash advances to reimburse PSW its
costs to construct water mains, are contributed to PSW by customers, real estate
developers and builders in order to extend water service to their properties.
6
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
The value of these contributions is recorded as Customers' Advances for
Construction. PSW 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.
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, not in excess of market value. Cost is
determined using the first-in, first-out method.
Stock-Based Compensation
In 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation", electing the provision of the statement allowing it to continue
its practice of not recognizing compensation expense related to granting of
stock options to the extent that the option price of the underlying stock was
equal to, or greater than, the market price on the date of option grant.
Disclosure of the impact on the results of operations, had the Company elected
to recognize compensation expense, is provided in the Employee Stock and
Incentive Plans footnote as required by the Statement.
Use of Estimates in Preparation of Consolidated Financial Statements
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles 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.
Reclassifications
Certain prior year amounts have been reclassified to conform with
current year's presentation.
Acquisitions
During 1997, PSW made the following acquisitions: in January, the
franchise rights and the water utility assets of Cherry Water Company; in
September, the franchise rights and water utility assets of Perkiomen Township
and in September, the franchise rights and both the water and wastewater utility
assets of the Peddler's View Utility Company. The systems acquired in 1997
incorporate two square miles of service area near PSW's existing territory. The
total purchase price for the three water systems and wastewater system acquired
in 1997 was $1,226. The annual revenues from these systems approximate $300, and
revenues included in the consolidated financial statements during the period
owned by PSW were $175.
During 1996, PSW made the following acquisitions: in October the
franchise rights and the water utility assets of Hatboro Borough Authority; in
November, Utility Group Services Corporation ("UGS") which owned three water
7
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
utilities and a wastewater utility; in December, the franchise rights and the
water utility assets of Bristol Borough Water and Sewer Authority and at various
times during 1996 the franchise rights and the water utility assets of three
smaller water systems. The total purchase price for the eight water systems and
wastewater system acquired in 1996 was $47,889, including the issuance of $3,220
of the Company's preferred stock and the assumption of $2,547 in liabilities.
These systems have a combined service territory of 64 square miles. Revenues
included in the consolidated financial statements related to the systems
acquired in 1996 were $5,902 in 1997 and $466 in 1996.
In May 1995, PSW purchased the franchise rights and the water utility
assets of Media Borough ("Media"). The Media system covers a 23 square mile
service area contiguous to PSW's service territory. In addition, PSW purchased
the franchise rights and the water utility assets of four smaller water systems
in 1995 that cover a combined service territory of four square miles. PSW paid
$26,351 for the water systems acquired in 1995. These systems serve customers
within or contiguous to the boundaries of PSW's existing service territory.
Revenues included in the consolidated financial statements related to the water
supply systems acquired in 1995 were $4,954 in 1997, $4,470 in 1996 and $2,820
in 1995.
In addition, in January 1998, PSW purchased the franchise rights and
the water utility assets of West Chester Area Municipal Authority ("West
Chester") for $22,400 in cash, subject to minor adjustment related to the final
value of current assets transferred and recent capital expenditures. The West
Chester service territory covers 16 square miles and is contiguous to PSW's
territory. The annual revenues of the West Chester system approximate $4,500.
PSW has also entered into a letter of intent to acquire the Flying Hills Water
Company ("Flying Hills") in a purchase transaction for approximately 45,000
shares of the Company's Common Stock. This transaction, which is subject to
final negotiation and the approval of the PUC, is expected to be completed in
the first quarter of 1998. The Flying Hills system covers a one square mile area
in Berks County near Reading, Pennsylvania and is 16 miles from the nearest edge
of PSW's system. The annual revenues of the Flying Hills system approximate
$200.
Property, Plant and Equipment
December 31,
------------------------
1997 1996
------------------------
Utility plant and equipment $641,303 $604,298
Utility construction work in progress 12,426 6,232
Non-utility plant and equipment 2,282 2,282
------------------------
Total property, plant and equipment $656,011 $612,812
========================
Depreciation is computed based on estimated useful lives of 5 to 110
years for utility plant and 3 to 10 years for both utility transportation and
mechanical equipment and all non-utility plant and equipment.
8
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
Accounts Receivable
December 31,
-----------------
1997 1996
-----------------
Billed water revenue $ 9,230 $ 9,760
Unbilled water revenue 13,949 11,764
Other 855 690
-----------------
24,034 22,214
Less allowance for doubtful accounts 500 300
-----------------
Net accounts receivable $23,534 $21,914
=================
All of the Company's customers are located in southeastern
Pennsylvania. No single customer accounted for more than one percent of the
Company's sales in 1997 or 1996 and no account receivable from any customer
exceeded one percent of the Company's total stockholders' equity.
Regulatory Asset
The regulatory asset represents costs which have been prudently
incurred and are expected to be fully recovered in future rates. The two
components of this asset are deferred income taxes and postretirement benefits
other than pensions. 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 portion of the asset related to postretirement benefits other than pensions
represents costs that were deferred during the period 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 in 1994. Amortization of the amount
deferred for postretirement benefits other than pensions began in 1994 and is
currently being recovered in rates.
December 31,
-------------------
1997 1996
-------------------
Income taxes $49,229 $46,381
Postretirement benefits other than pensions 1,974 2,110
-------------------
$51,203 $48,491
===================
9
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
Income Taxes
Total income tax expense is allocated as follows:
Years Ended December 31,
---------------------------------
1997 1996 1995
---------------------------------
Income from continuing operations $ 15,873 $13,971 $12,901
Common stockholders' equity related
to stock option activity which
reduces taxable income (401) (126) (44)
Discontinued operations - 520 200
---------------------------------
$ 15,472 $14,365 $13,057
=================================
Income tax expense attributable to income from continuing operations
consists of:
Years Ended December 31,
-----------------------------------
1997 1996 1995
-----------------------------------
Current:
Federal $ 8,742 $ 8,084 $ 7,688
State 2,800 2,600 2,514
-----------------------------------
11,542 10,684 10,202
-----------------------------------
Deferred:
Federal 4,004 3,002 2,565
State 327 285 134
-----------------------------------
4,331 3,287 2,699
-----------------------------------
Total tax expense $15,873 $13,971 $12,901
===================================
The significant components of deferred income tax expense are as
follows:
Years Ended December 31,
----------------------------------
1997 1996 1995
----------------------------------
Excess of tax over financial statement depreciation $ 3,308 $ 2,458 $ 2,323
Amortization of deferred investment tax credits (105) (115) (151)
Current year investment tax credits deferred 35 40 90
Differences in basis of fixed assets due to variations
in tax and book accounting methods that reverse
through depreciation 860 770 819
Customers' advances for construction, net 556 196 (443)
Other, net (323) (62) 61
----------------------------------
Total deferred income tax expense $ 4,331 $ 3,287 $ 2,699
==================================
The statutory Federal tax rate is 35% and the Pennsylvania Corporate
Net Income Tax rate is 9.99% for all years presented.
10
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
The reasons for the differences between amounts computed by applying
the statutory Federal income tax rate to income from continuing operations
before Federal tax and the actual Federal tax expense are as follows:
Years Ended December 31,
--------------------------------
1997 1996 1995
--------------------------------
Computed Federal tax expense at statutory rate $12,508 $10,795 $9,899
Increase (decrease) in tax expense for items to be
recovered in future rates:
Depreciation expense 70 179 132
Losses on asset disposals (2) (12) (35)
Amortization of deferred investment tax credits (105) (115) (151)
Preferred stock dividend 197 180 221
Other, net 78 59 187
--------------------------------
Actual Federal tax expense $12,746 $11,086 $10,253
================================
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,
---------------------
1997 1996
---------------------
Deferred tax assets:
Customers' advances for construction $ 9,198 $ 9,753
Costs expensed for book not deducted
for tax, principally accrued expenses
and bad debt reserves 2,393 2,638
Other 642 389
---------------------
Total gross deferred tax assets 12,233 12,780
---------------------
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 71,888 65,666
Deferred taxes associated with the gross-up
of revenues necessary to recover, in rates,
the effect of temporary differences 18,937 17,801
Deferred investment tax credit 4,218 4,288
Other 319 974
----------------------
Total gross deferred tax liabilities 95,362 88,729
----------------------
Net deferred tax liability $83,129 $75,949
======================
The Company made income tax payments, which include amounts related to
discontinued operations, of $11,346, $10,199 and $9,730 in 1997, 1996 and 1995,
respectively. The Company's Federal income tax returns for all years through
1993 have been closed.
11
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
Commitments
PSW maintains agreements with the Chester Water Authority and the Bucks
County Water and Sewer Authority 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 2017. The
estimated annual commitments related to such purchases total approximately
$2,852 through 2002. PSW purchased approximately $2,978, $2,889 and $2,839 of
water under these agreements during the years ended December 31, 1997, 1996 and
1995, respectively.
PSW leases motor vehicles and other equipment under operating leases
that are noncancelable and expire on various dates through 2002. During the next
five years, $2,698 of future minimum lease payments are due: $1,026 in 1998,
$834 in 1999, $504 in 2000, $315 in 2001 and $8 in 2002. PSW leases parcels of
land on which its Media treatment plant and other facilities are situated and
adjacent parcels that are used for watershed protection. The operating lease is
noncancelable, expires in 2045 and contains certain renewal provisions. The
lease is subject to an adjustment every five years based on changes in the
Consumer Price Index. During each of the next five years, $292 of lease payments
for land are due.
Rent expense was $1,297, $1,332 and $1,067 for the years ended December
31, 1997, 1996 and 1995, respectively.
Long-term Debt and Loans Payable
The Consolidated Statements of Capitalization provides a listing of
long-term debt and loans outstanding as of December 31, 1997 and 1996. The
supplemental indentures with respect to certain issues of the First Mortgage
Bonds restrict the ability of PSW to declare dividends, in cash or property, or
repurchase or otherwise acquire PSW's stock. As of December 31, 1997,
approximately $120,000 of retained earnings were free of these restrictions.
Certain supplemental indentures also prohibit PSW from making loans to or
purchasing the stock of the Company.
Excluding amounts due under PSW's revolving credit agreement, the
Company's sinking fund payments and debt maturities for the next five years are
as follows:
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
Sinking fund payments $ 2,448 $ 2,452 $ 2,457 $ 2,462 $ 2,867
Maturities - - - - 10,000
----------------------------------------------------------------------
Total $ 2,448 $ 2,452 $ 2,457 $ 2,462 $12,867
======================================================================
In July 1997, PSW established a two-year $150,000 medium-term note
program providing 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. This program replaced a similar program that expired in March 1997.
The notes issued under this program are secured by the Thirty-First Supplement
to the trust indenture relating to PSW's First Mortgage Bonds. During 1997,
issuances through these programs were as follows: $10,000 in March 1997, 7.06%
Series due 2004; $10,000 in July 1997, 6.75% Series due 2007; $10,000 in October
1997, 6.3% Series due 2002. During 1996, issuances through these programs were
as follows: $10,000 in April 1996, 6.99% Series due 2006; $10,000 in July 1996,
7.47% Series due 2003; and $10,000 in November 1996, 6.83% Series due 2003. The
proceeds from these issuances were used to fund acquisitions, the retirement of
the First Mortgage Bonds noted below and for PSW's ongoing capital program.
12
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
In January 1998, PSW issued $10,000 6.14% Series due 2008 and $10,000
5.8% Series due 2003 through the medium-term note program. Proceeds from these
issues were used to reduce the balance of PSW's revolving credit facility.
In January 1996, PSW retired $5,000 of First Mortgage Bonds, 7.875%
Series due 1997, at a premium of .331% or $17 and $4,150 of First Mortgage
Bonds, 8.4% Series due 2002, at a premium of 2.1% or $87. In April 1996, PSW
retired $10,000 of First Mortgage Bonds, 10.65% Series due 2006, at a premium of
5.04% or $504. The unamortized bond issuance expenses related to the retirements
in 1996 were $25. The premiums paid on the early retirement of debt, along with
the related unamortized bond issuance expense, are capitalized and amortized, in
accordance with the Uniform System of Accounts prescribed by the PUC, over the
life of the long-term debt used to fund the redemption.
In February 1994, PSW entered into a revolving credit agreement with
four banks. In January 1998, PSW extended its revolving credit agreement, that
was due to expire in March 1998, until January 2000 and increased the available
borrowings under this facility from $30,000 to $50,000. Accordingly, amounts
borrowed under this facility as of December 31, 1997 have been classified as
long-term debt. The agreement was also amended in prior years to temporarily
increase the available borrowings under this facility. Interest under this
facility is based, at PSW's option, on the prime rate, an adjusted federal funds
rate, an adjusted certificate of deposit rate corresponding to the interest
period selected, an adjusted Euro-Rate corresponding to the interest period
selected or at rates offered by the banks. This agreement restricts the total
amount of short-term borrowings of PSW. A commitment fee of 1/8 of 1% is charged
on the unused portion of the loan. The average cost of borrowing under this
facility was 6.08% and 6.02%, and the average borrowing was $36,746 and $14,326,
during 1997 and 1996, respectively. The maximum amount outstanding at the end of
any one month was $48,743 in 1997 and $39,727 in 1996.
At December 31, 1997 and 1996, the Company and PSW had combined
short-term lines of credit of $16,000. Funds borrowed under these lines are
classified as loans payable and are used to provide working capital. The average
borrowing under the lines was $8,009 and $5,123 during 1997 and 1996,
respectively. The maximum amount outstanding at the end of any one month was
$11,090 in 1997 and $6,820 in 1996. 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 1997 and 1996 was 6.1%.
The total amount of interest paid on all borrowings, net of amounts
capitalized, was $17,616, $15,503 and $14,923 in 1997, 1996 and 1995,
respectively. The proforma weighted cost of long-term debt at December 31, 1997
and 1996 was 7.5% and 7.7%, respectively.
13
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
Preferred Stock of Subsidiary with Mandatory Redemption Requirements
PSW is authorized to issue up to 1,000,000 shares of preferred stock,
with stated par value, in one or more series. In 1991, PSW issued 100,000 shares
of 8.66% Series 1 Cumulative Preferred Stock, at par value of $100 per share in
a private placement. Dividends on this issue are payable quarterly and are
cumulative. PSW may not pay dividends on its common stock unless provision has
been made for payment of the preferred dividends. As of December 31, 1997, all
preferred dividends have been provided for. These shares are subject to
mandatory annual redemption equal to the par value of 14,285 shares plus accrued
dividends. In addition, PSW has exercised its right to call 14,285 shares per
year starting in 1995, up to a maximum of 15,000 shares over the life of the
issue, at par. The balance may be called, beginning in 1998, at a specified
price above par.
In December 1997, PSW provided notice to the holder of the preferred
stock of its intention to call all the remaining shares in January 1998. As
required by the share purchase agreement, 14,285 shares were redeemed at par
value and a 4% premium or $111 was paid on the remaining 27,860 shares
outstanding. Accordingly, $4,214 has been classified as the current portion of
preferred stock as of December 31, 1997.
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 as of December 31, 1997 is $234,919 and $254,998, respectively.
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 carrying values of $25,810 and $6,092, respectively at December
31, 1997. Their relative fair values cannot be accurately estimated since 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 2018 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.
Stockholders' Equity
At December 31, 1997, 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
32,200 shares as Series B Preferred Stock, $1.00 par value. The Series A
Preferred Stock, as well as the undesignated shares of Series Preferred Stock,
remains unissued. In 1996, the Company issued all of the 6.05% Series B
Preferred Stock in connection with the acquisition of UGS. The Series B
Preferred Stock is recorded on the balance sheet at its liquidation value of
$100 per share. The dividends, payment of which commenced December 1, 1996, are
cumulative and payable quarterly. PSC may not pay dividends on common stock
unless provision has been made for payment of the preferred dividends. Under the
provisions of this issue, the holders may redeem the shares, in whole or in
part, at the liquidation value beginning December 1, 1998 and the Company may
redeem up to 20% of this issue each year beginning December 1, 2001 and, at the
holders' option, this redemption may be made in cash or through the issuance of
debt with a five year maturity at an interest rate of 6.05%. As of December 31,
1997, all dividends have been provided for.
14
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
In December 1997, the Company's Board of Directors declared a 4-for-3
common stock split effected in the form of a 33.3% stock distribution for all
common shares outstanding, to shareholders of record on December 15, 1997.
Common shares outstanding do not include shares held by the Company in treasury.
The new shares were distributed on January 12, 1998. The Company's par value of
$.50 per share remained unchanged and $3,276 was transferred from Capital in
Excess of Par Value to Common Stock to record the split. All share and per share
data for all periods presented have been restated to give effect to the stock
split.
At December 31, 1997, the Company had 40,000,000 shares of common stock
authorized; par value $.50. Shares outstanding at December 31, 1997, 1996 and
1995 were 26,210,654, 25,598,105 and 24,377,496, respectively. Treasury shares
held at December 31, 1997, 1996 and 1995 were 376,510, 262,230 and 259,125,
respectively.
The following table summarizes the activity of common stockholders'
equity:
Capital in
Common Treasury excess of Retained
stock stock par value earnings Total
--------------------------------------------------------------------------
Balance at December 31, 1994 $ 5,979 $ (3,239) $ 102,564 $ 38,491 $ 143,795
Net income -- -- -- 18,400 18,400
Dividends -- -- -- (13,546) (13,546)
Sale of stock 217 392 7,621 -- 8,230
Repurchase of stock -- (733) -- -- (733)
Equity Compensation Plan 1 -- 31 -- 32
Exercise of stock options 27 -- 771 -- 798
--------------------------------------------------------------------------
Balance at December 31, 1995 6,224 (3,580) 110,987 43,345 156,976
--------------------------------------------------------------------------
Net income -- -- -- 20,722 20,722
Dividends -- -- -- (14,795) (14,795)
Stock split 3,140 -- (3,140) -- --
Sale of stock 298 693 11,546 -- 12,537
Repurchase of stock -- (760) -- -- (760)
Equity Compensation Plan 1 -- 38 -- 39
Exercise of stock options 68 -- 2,008 -- 2,076
--------------------------------------------------------------------------
Balance at December 31, 1996 9,731 (3,647) 121,439 49,272 176,795
--------------------------------------------------------------------------
Net income -- -- -- 22,993 22,993
Dividends -- -- -- (16,129) (16,129)
Stock split 3,276 -- (3,276) -- --
Sale of stock 178 506 7,128 -- 7,812
Repurchase of stock -- (2,829) -- -- (2,829)
Equity Compensation Plan 1 -- 50 -- 51
Exercise of stock options 108 -- 2,724 -- 2,832
--------------------------------------------------------------------------
Balance at December 31, 1997 $ 13,294 $ (5,970) $ 128,065 $ 56,136 $ 191,525
==========================================================================
In January 1998, the Company registered 1,100,000 shares of common
stock for sale in a public offering that it expects to complete in February
1998. Based on the market price of the Company's common stock in late January
15
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
1998, the Company anticipates proceeds of $25,239, net of expenses, from this
offering, $28,706 if the underwriters' option to sell an additional 150,000
shares is exercised. The proceeds of this offering will be used to make a
$19,000 equity contribution to PSW, that PSW will use to reduce the balance of
its revolving credit loan, and to repay short-term debt of the Company.
The Company has adopted a Dividend Reinvestment and Direct Stock
Purchase Plan in early 1998 that replaced the Customer Stock Purchase Program
for PSW's customers, and the Dividend Reinvestment and Optional Stock Purchase
Program for existing shareholders. Under the new plan, reinvested dividends will
continue to be used to purchase original issue shares of common stock at a five
percent discount from the current market value. Under the direct stock purchase
program, shares may be purchased by investors throughout the year, instead of
during limited subscription periods, at market price and the shares will be
purchased by the Company's transfer agent in the open-market at least weekly and
will not be original issue shares of stock. The Plans that were replaced
exclusively used original issue shares and 489,296, 1,007,633 and 868,068
original issue shares of common stock were sold providing the Company with
$7,567, $12,280 and $7,846 of additional capital, after expenses, during 1997,
1996 and 1995, respectively.
In August 1997, the Board of Directors approved a resolution
authorizing the Company to purchase, from time to time, up to 500,000 shares of
its common stock in the open market or through privately negotiated
transactions. The remaining number of shares authorized for purchase was
adjusted as a result of the 4-for-3 stock split so that the total number of
shares authorized for purchase as of December 31, 1997 was 669,612. In 1993, the
Board of Directors approved a similar authorization. During 1997, 1996 and 1995,
152,000, 4,339 and 78,912 shares have been purchased at a net cost of $2,284,
$52 and $733, respectively. For comparative purposes the number of shares
purchased is presented as if they were adjusted for the effect of the 1997 and
1996 stock splits. As of December 31, 1997, 628,145 shares remain available for
purchase by the Company.
Net Income per Common Share and Equity per Common Share
In December 1997, the Company adopted SFAS No. 128, "Earnings per
Share" which prescribes two methods for calculating net income per common share:
Basic and Diluted methods. These calculations differ from those used in prior
periods and as a result all prior period earnings per share data have been
restated to reflect the adoption of SFAS No. 128 as well as the 1997 4-for-3
stock split. 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 adoption of this statement had
no effect on the results of operations, financial conditions, or long-term
liquidity. The following table summarizes the shares used in computing Basic and
Diluted net income per share:
Years ended December 31,
---------------------------------
1997 1996 1995
---------------------------------
Average common shares outstanding during
the period for Basic computation 25,908 24,966 23,803
Dilutive effect of employee stock options 365 296 113
---------------------------------
Average common shares outstanding during
the period for Diluted computation 26,273 25,262 23,916
=================================
16
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
Equity per common share was $7.31 and $6.91 at December 31, 1997 and
1996 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 (the "Current 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 25% 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 30% 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 25% 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 $.02 per Right at any time before the Rights become exercisable. The
Rights will expire on March 1, 1998, unless previously redeemed.
At the meeting of the Board of Directors scheduled for February 3,
1998, management is expected to recommend that the Board of Directors adopt a
new Shareholder Rights Plan (the "New Plan") to replace the Current Plan. The
New Plan, which would expire on March 1, 2008, would be substantially the same
as the Current Plan except that the beneficial ownership threshold that would
trigger the exercisability of the rights issued to purchase Company Common Stock
would be reduced from 25% of the outstanding Common Stock to approximately 20%
of the outstanding Common Stock.
Employee Stock and Incentive Plans
Under the 1994 Equity Compensation Plan ("1994 Plan"), as amended, 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"). In May 1996, the
Shareholders authorized an increase to the number of shares from 900,000 shares
to 1,900,000 shares of common stock for issuance under the 1994 plan, with the
maximum number of restricted stock grants limited to 50,000 shares. Awards under
this plan are made by the Board of Directors or a committee of the Board.
Options under the 1994 plan, as well as the earlier 1988 Stock Option
Plan were issued at the market price of the stock on the day of the grant.
Options are exercisable in installments ranging from 20% to 33% annually,
starting one year from the date of the grant and expire 10 years from the date
of the grant.
17
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
The following table summarizes stock option transactions for the two
plans:
Years Ended December 31,
------------------------------------
1997 1996 1995
------------------------------------
Options granted 263,333 254,000 241,000
Options terminated (33,405) (38,136) -
Options exercised (292,492) (240,201) (106,624)
------------------------------------
Net change (62,564) (24,337) 134,376
====================================
Balance of shares under option 968,137 1,030,701 1,055,038
====================================
Options exercised during 1997 ranged in price from $6.47 per share to
$11.19 per share. The shares under option at December 31, 1997 are exercisable
at prices ranging from $6.59 to $15.14 per share. At December 31, 1997, 439,527
shares were exercisable, and 932,008 options under the 1994 Plan were still
available for grant.
Under SFAS No. 123, "Accounting for Stock-Based Compensation", the
Company elects to continue to apply the provisions of APB Opinion No. 25 and to
provide the proforma disclosure provisions of this statement. Accordingly, no
compensation cost has been recognized in the financial statements for stock
options that have been granted. Had the Company determined compensation cost
based on the fair value at the grant date for its stock options under SFAS No.
123, the Company's net income available to common stock and Basic and Diluted
net income per share would have been reduced to the proforma amounts indicated
below:
Years Ended December 31,
-------------------------------
1997 1996 1995
-------------------------------
Net income available to common stock:
As reported $ 22,993 $20,722 $18,400
Proforma 22,229 20,337 18,048
Basic net income per share:
As reported $ 0.89 0.83 $ 0.77
Proforma 0.86 0.81 0.76
Diluted net income per share:
As reported $ 0.88 $ 0.82 $ 0.77
Proforma 0.85 0.81 0.75
18
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(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 1997, 1996 and 1995 was $2.90, 1.52 and $1.46 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:
1997 1996 1995
------------------------------------
Expected life (years) 10 10 10
Interest rate 6.6% 6.4% 7.4%
Volatility 13.8% 14.0% 12.5%
Dividend yield 4.0% 5.2% 6.3%
Dividend equivalents provide the grantee with an amount equal to the
dividends paid on a share of common stock over a specified period of time, not
to exceed four years, multiplied by the number of dividend equivalents awarded.
Payments of these awards are deferred until the completion of certain objectives
during a performance period established by a Committee of the Board at the time
of grant. A performance period is generally four years but may be adjusted by
the Committee to as long as eight years or as short as two years depending on
the Company's success in completing the objectives. Dividend equivalents are
"compensatory" and, as such, are charged to operating expense over the
performance period. The effect of changes to the performance period is accrued
when known or projected. The Board granted 103,974, 98,975 and 90,977 dividend
equivalents in 1997, 1996 and 1995, respectively, and costs associated with
these awards were $330 in 1997, $234 in 1996 and $197 in 1995. During 1997 and
1996, payments associated with the dividend equivalents of $191 and $124,
respectively, were made to recipients.
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 1997, 1996 and 1995, 3,600, 3,200 and 3,600 shares of
restricted stock were granted with a restriction period of six 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 less payments made by the
grantee and is recognized as expense in the year of the grant.
19
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
Pension Plans and Other Postretirement Benefits
The Company has defined benefit pension plans that cover its full-time
employees. Retirement benefits under the plans 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 these plans annually at a level
which is deductible for income tax purposes and which provides assets sufficient
to meet its pension obligations. As a result of certain limitations imposed by
the Internal Revenue Code with respect to payments under qualified plans, the
Company, in 1989, adopted 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 one current and one retired employee. The net pension costs
and obligations of the qualified and non-qualified plans are included in the
tables which follow.
The Company's pension expense includes the following components:
Years Ended December 31,
-------------------------------------
1997 1996 1995
-------------------------------------
Benefits earned during the year $ 1,432 $ 1,373 $ 905
Interest cost on projected benefit obligation 3,796 3,523 3,304
Actual return on plan assets (11,502) (6,784) (9,256)
Net amortization and deferral 7,222 2,904 6,029
Capitalized costs (40) (34) (133)
Rate-regulated adjustment (567) (707) (311)
-------------------------------------
Net pension cost $ 341 $ 275 $ 538
=====================================
The rate-regulated adjustment set forth above is required in order to
reflect pension expense for PSW in accordance with the method used in
establishing water rates.
20
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
The assets and obligations of the plans are as follows:
December 31,
------------------------
1997 1996
------------------------
Accumulated benefit obligation:
Vested $ 43,894 $ 38,991
Non-vested 2,443 2,210
------------------------
Total $ 46,337 $ 41,201
========================
Projected benefit obligation $ 57,157 $ 51,321
Plan assets at fair value, primarily equity and fixed
income commingled funds 60,112 51,249
------------------------
Plan assets less than (in excess of) projected benefit obligation (2,955) 72
Unrecognized net gain from past experience different from that
assumed and effects of changes in assumptions 7,715 3,522
Unrecognized prior service cost (1,737) (1,378)
Rate-regulated adjustment (1,662) (1,095)
Unrecognized net obligation (364) (453)
------------------------
Accrued pension costs included in other
current liabilities $ 997 $ 668
========================
The accumulated and projected benefit obligations were calculated using
the projected unit credit method and reflect the following assumptions: discount
rates of 7% for 1997, 7.25% for 1996 and 7% for 1995; increase in future
compensation levels of 5.5% for all years presented; and long-term rate of
return on assets of 9% for all years presented.
In addition to providing pension benefits, PSW offers certain
Postretirement Benefits other than Pensions ("PBOPs") to employees retiring with
at least 15 years of service. These PBOPs include continuation of medical and
prescription drug benefits for all eligible retirees and a life insurance policy
for eligible union retirees.
The Company's costs for postretirement benefits other than pensions
includes the following components:
Years Ended December 31,
---------------------------------
1997 1996 1995
---------------------------------
Benefits earned during the year $ 389 $ 296 $ 208
Interest cost 919 872 994
Return on plan assets (647) (173) (101)
Net amortization and deferral 916 567 655
Amortization of regulatory asset 136 136 136
---------------------------------
Gross PBOP cost 1,713 1,698 1,892
Capitalized costs (407) (79) (94)
---------------------------------
Net PBOP cost $ 1,306 $ 1,619 $ 1,798
=================================
21
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
The assets and liabilities of the plans for postretirement benefits
other than pensions are as follows:
December 31,
---------------------------
1997 1996
---------------------------
Accumulated postretirement benefit obligation (APBO):
Retirees $ 6,244 $ 6,246
Fully eligible active employees 2,857 3,325
Other employees 3,626 3,045
---------------------------
Total APBO 12,727 12,616
Fair value of plan assets 5,437 3,500
---------------------------
APBO in excess of plan assets 7,290 9,116
Unrecognized net transition obligation (11,151) (11,894)
Unrecognized net gain 5,892 4,974
---------------------------
Accrued PBOP cost included in other liabilities $ 2,031 $ 2,196
===========================
The APBO is calculated utilizing the following assumptions: discount
rate of 7%; medical inflation rates of 5% for those employees not eligible by
December 31, 1993, and 8%, reducing to 4.5% by 2002 for all others; a 9% return
on plan assets for all years presented. The effect of a 1% increase in the
assumed medical inflation rates would be to increase the APBO and the 1997 PBOP
costs by $770 and $59, respectively. The Company funds its gross PBOP cost
through various trust accounts.
Water Rates
On October 23, 1997, the Pennsylvania Public Utility Commission ("PUC")
approved a rate settlement reached between PSW and the parties actively
litigating the rate application PSW filed in April 1997. The settlement is
designed to increase PSW's annual revenue by $9,300 or 7.3% over the level in
effect at the time of the filing. The rates in effect at the time of the filing
included a 1% or $1,300 Distribution System Improvement Charge ("DSIC").
Consequently, the settlement resulted in a total base rate increase of $10,600
or 8.3%. As a part of the settlement, the DSIC was reset to zero and the Company
agreed not to file a base rate increase request prior to April 1999, absent
extraordinary circumstances.
PSW was permitted by the PUC to increase its base rates by 5.3%
effective October 27, 1995 which was designed to provide additional annual
revenues of approximately $6,150.
In 1996, the PUC approved PSW's request to add a DSIC to its water
bills. The DSIC enabled PSW to add a surcharge to customer bills beginning
January 1, 1997 reflecting the capital costs and depreciation related to certain
distribution system improvement projects completed and placed into service
between base rate filings. PSW is permitted to request adjustments to the DSIC
quarterly to reflect subsequent capital expenditures and it is reset to zero
when new base rates that reflect the costs of those additions become effective.
The maximum DSIC that can be in effect at any time is 5%. The DSIC increased
revenues in 1997 by $1,104. In October 1997, the existing DSIC rate of 1.82% was
eliminated with the adoption of new base rates.
In addition to its base rates, PSW has utilized a surcharge or credit
on its bills to reflect certain changes in Pennsylvania State taxes until such
time as the tax changes are incorporated into base rates. In October 1995, the
existing credit of 1.04% was eliminated with the adoption of new base rates. PSW
was required to initiate a revenue credit in 1994 in order to provide its
customers with the savings associated with Pennsylvania tax rate decreases. The
credit decreased revenues in 1995 by $504.
22
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
Discontinued Operations
The Board of Directors had authorized the sale of substantially all of
the Company's non-regulated businesses and the last of these businesses was sold
in 1993. At the time the Board of Directors authorized the sale of these
businesses, the Company established reserves for: projected operating losses of
these businesses subsequent to their sale authorizations; estimated losses on
the sale transactions; and certain future costs, including administrative and
legal services related to the sales, contingent legal and lease obligations and
certain employee costs. These reserves were recorded on the balance sheet net of
related income tax benefits. During 1997 and 1996, contingent sale proceeds of
$250 and $337 were received and credited to the reserve. During 1996 and 1995,
$18 and $178 of payments associated with discontinued operations were charged to
the reserve.
As a result of the continuing assessment of asserted and unasserted
legal claims related to these businesses, the passage of time, which reduced
certain lease contingencies, and the receipt of contingent sale proceeds, the
Company has determined that, the net reserves were in excess of estimates of
potential costs. Consequently, the contingent sale proceeds received in 1997
were included in Earned Revenues. In 1996 and 1995, the Company reversed $965
and $370 net of related income taxes, of these reserves. At December 31, 1997
there remains a balance in the reserve for discontinued operations of $1,009
which is included in other accrued liabilities.
23
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except per share amounts)
Selected Quarterly Financial Data (Unaudited)
- ---------------------------------------------------
(in thousands of dollars, except per share amounts)
Total
First Second Third Fourth Year
---------------------------------------------------------------
1997
- --------------------------------------------------------------------------------------------------------------------
Earned revenues $ 31,021 $ 33,315 $ 36,754 $ 35,081 $ 136,171
Operating expenses 13,068 13,295 14,466 15,070 55,899
Net income available to common
stock 4,460 5,778 7,323 5,432 22,993
Basic net income per common share 0.17 0.23 0.28 0.21 0.89
Diluted net income per common share 0.17 0.22 0.28 0.21 0.88
Dividend paid per common share 0.152 0.152 0.159 0.159 0.622
Price range of common stock
- high 15.47 15.10 18.00 22.18 22.18
- low 11.72 11.44 14.07 15.10 11.44
1996
- --------------------------------------------------------------------------------------------------------------------
Earned revenues $ 29,290 $ 30,683 $ 30,831 $ 31,699 $ 122,503
Operating expenses 13,070 12,614 11,757 14,174 51,615
Income, continuing operations 3,968 5,281 5,847 4,661 19,757
Basic income per share, continuing
operations 0.16 0.21 0.24 0.18 0.79
Diluted income per share, continuing
operations 0.16 0.21 0.23 0.18 0.78
Income, discontinued operations - - 365 600 965
Basic and diluted income per share,
discontinued operations - - 0.02 0.02 0.04
Net income available to common
stock 3,968 5,281 6,212 5,261 20,722
Basic net income per common share 0.16 0.21 0.26 0.20 0.83
Diluted net income per common share 0.16 0.21 0.25 0.20 0.82
Dividend paid per common share 0.145 0.145 0.152 0.152 0.594
Price range of common stock
- high 11.57 12.57 12.94 14.91 14.91
- low 10.26 11.25 11.63 12.38 10.26
All per share data as presented has been adjusted for the 1997 common
stock split effected in the form of a stock distribution. High and low prices of
the Company's common stock are as reported on the New York Stock Exchange
Composite Tape.
24
PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES
SUMMARY OF SELECTED FINANCIAL DATA
(In thousands of dollars, except per share amounts)
Years ended December 31, 1997 1996* 1995* 1994* 1993*
---- ---- ------- ------ --------
PER COMMON SHARE:
Income from continuing operations
Basic $ 0.89 $ 0.79 $ 0.75 $ 0.68 $ 0.64
Diluted 0.88 0.78 0.75 0.68 0.64
Net income
Basic 0.89 0.83 0.77 0.68 0.64
Diluted 0.88 0.82 0.77 0.68 0.64
Cash dividends 0.62 0.59 0.57 0.55 0.54
Returns on average shareholders' equity(a) 12% 12% 12% 11% 11%
Book value at year end $ 7.31 $ 6.91 $ 6.44 $ 6.14 $ 5.95
Market value at year end 22.08 14.91 10.38 9.06 9.19
INCOME STATEMENT HIGHLIGHTS:
Earned revenues(a) $136,171 $122,503 $117,044 $108,636 $101,244
Depreciation and amortization(a) 14,580 13,333 11,557 10,330 10,935
Interest expense (a)(b) 17,738 15,541 15,178 13,636 13,169
Income before income taxes(a) 39,061 33,749 30,931 27,209 24,261
Provision for income taxes(a) 15,873 13,971 12,901 11,571 10,426
Income from continuing operations 23,188 19,778 18,030 15,638 13,835
Net income available to common stock 22,993 20,772 18,400 15,638 13,835
BALANCE SHEET HIGHLIGHTS:
Total assets $618,472 $582,944 $518,051 $460,062 $440,935
Property, plant and equipment, net 534,483 502,938 436,905 385,709 366,230
Stockholders' equity 194,745 180,015 156,976 143,795 135,934
Preferred stock with mandatory redemption(c) 4,214 5,643 7,143 10,000 10,000
Long-term debt(c) 234,919 229,962 188,985 153,082 150,176
Total debt 245,319 235,522 195,440 157,132 150,995
ADDITIONAL INFORMATION:
Net cash flows from operating activities(a) $ 41,843 $ 37,422 $ 32,954 $ 29,730 $ 27,049
Capital additions(a)(d) 38,960 31,389 33,182 27,379 27,958
Dividends on common stock 16,129 14,795 13,546 12,637 11,629
Number of metered water customers 287,516 284,141 264,865 249,533 247,195
Number of shareholders of common stock 13,894 13,650 12,209 11,243 10,811
Common shares outstanding (000) 26,210 25,598 24,377 23,436 22,860
Employees (full-time) 531 540 535 525 523
*Share and per share data has been restated for the 1997 4-for-3 stock split.
(a) Continuing operations only.
(b) Includes dividend on preferred stock of subsidiary and is net of allowance
for funds used during construction.
(c) Includes current portion.
(d) Excludes payments for acquired water systems of $1,226 in 1997, $42,122 in
1996, $26,351 in 1995, $612 in 1994 and $1,323 in 1993.