UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
FORM 10-Q
(Mark One)
For the quarterly period ended September 30, 2012
For the transition period from to
Commission File Number 1-6659
AQUA AMERICA, INC.
(Exact name of registrant as specified in its charter)
(610) 527-8000
(Registrant’s telephone number, including area code)
(Former Name, former address and former fiscal year, if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12(b)-2 of the Exchange Act.:
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of October 24, 2012: 139,941,476
AQUA AMERICA, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Part I – Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheets (unaudited) – September 30, 2012 and December 31, 2011
Consolidated Statements of Net Income (unaudited) - Nine Months Ended September 30, 2012 and 2011
Consolidated Statements of Net Income (unaudited) - Three Months Ended September 30, 2012 and 2011
Consolidated Statements of Comprehensive Income (unaudited) - Nine and Three Months Ended September 30, 2012 and 2011
Consolidated Statements of Capitalization (unaudited) – September 30, 2012 and December 31, 2011
Consolidated Statement of Equity (unaudited) – Nine Months Ended September 30, 2012
Consolidated Statements of Cash Flow (unaudited) – Nine Months Ended September 30, 2012 and 2011
Notes to Consolidated Financial Statements (unaudited)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II – Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 4. Mine Safety Disclosures
Item 6. Exhibits
Signatures
Exhibit Index
1
CONSOLIDATED BALANCE SHEETS
(In thousands of dollars, except per share amounts)
(UNAUDITED)
Assets
Property, plant and equipment, at cost
Less: accumulated depreciation
Net property, plant and equipment
Current assets:
Cash and cash equivalents
Accounts receivable and unbilled revenues, net
Deferred income taxes
Inventory, materials and supplies
Prepayments and other current assets
Assets of discontinued operations held for sale
Total current assets
Regulatory assets
Deferred charges and other assets, net
Funds restricted for construction activity
Goodwill
Aqua America stockholders’ equity:
Common stock at $.50 par value, authorized 300,000,000 shares,issued 140,697,726 and 139,525,580 in 2012 and 2011
Capital in excess of par value
Retained earnings
Treasury stock, at cost, 767,178 and 710,482 shares in 2012 and 2011
Accumulated other comprehensive income
Total Aqua America stockholders’ equity
Noncontrolling interest
Total equity
Long-term debt, excluding current portion
Commitments and contingencies (See Note 13)
Current liabilities:
Current portion of long-term debt
Loans payable
Accounts payable
Accrued interest
Accrued taxes
Dividends payable
Other accrued liabilities
Liabilities of discontinued operations held for sale
Total current liabilities
Deferred credits and other liabilities:
Deferred income taxes and investment tax credits
Customers’ advances for construction
Regulatory liabilities
Other
Total deferred credits and other liabilities
Contributions in aid of construction
See notes to consolidated financial statements beginning on page 9 of this report.
2
CONSOLIDATED STATEMENTS OF NET INCOME
(In thousands, except per share amounts)
Operating revenues
Operating expenses:
Operations and maintenance
Depreciation
Amortization
Taxes other than income taxes
Operating income
Other expense (income):
Interest expense, net
Allowance for funds used during construction
Gain on sale of other assets
Equity earnings in joint venture
Income from continuing operations before income taxes
Provision for income taxes
Income from continuing operations
Discontinued operations:
Income from discontinued operations before income taxes
Income (loss) from discontinued operations
Net income attributable to common shareholders
Income from continuing operations per share:
Basic
Diluted
Income from discontinued operations per share:
Net income per common share:
Average common shares outstanding during the period:
Cash dividends declared per common share
3
Income (loss) from discontinued operations per share:
4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands of dollars)
Other comprehensive income, net of tax:
Unrealized holding gain (loss) on investments (1) (2)
Reclassification adjustment for gain reported in net income (3) (4)
Comprehensive income
5
CONSOLIDATED STATEMENTS OF CAPITALIZATION
Common stock, $.50 par value
Treasury stock, at cost
Long-term debt:
Long-term debt of subsidiaries (substantially secured by utility plant):
Interest Rate Range
0.00% to 0.99%
1.00% to 1.99%
2.00% to 2.99%
3.00% to 3.99%
4.00% to 4.99%
5.00% to 5.99%
6.00% to 6.99%
7.00% to 7.99%
8.00% to 8.99%
9.00% to 9.99%
10.40%
Notes payable to bank under revolving credit agreement, variable rate, due March 2017
Unsecured notes payable:
Notes at 3.57% due 2027
Notes ranging from 4.62% to 4.87%, due 2013 through 2024
Notes ranging from 5.01% to 5.95%, due 2014 through 2037
Less: long-term debt of discontinued operations
Total capitalization
6
CONSOLIDATED STATEMENT OF EQUITY
Balance at December 31, 2011
Net income
Other comprehensive loss net of income tax of $99
Dividends paid
Dividends declared
Sale of stock (436,861 shares)
Repurchase of stock (62,997 shares)
Equity compensation plan (15,518 shares)
Exercise of stock options (726,068 shares)
Stock-based compensation
Employee stock plan tax benefits
Balance at September 30, 2012
7
CONSOLIDATED STATEMENTS OF CASH FLOW
Cash flows from operating activities:
Adjustments to reconcile income from continuing operations to net cash flows from operating activities:
Depreciation and amortization
Provision for doubtful accounts
Gain on sale of utility system
Net increase in receivables, inventory and prepayments
Net increase in payables, accrued interest, accrued taxes and other accrued liabilities
Operating cash flows from continuing operations
Operating cash flows (used in) from discontinued operations, net
Net cash flows from operating activities
Cash flows from investing activities:
Property, plant and equipment additions, including allowance for funds used during construction of $3,484 and $5,689
Acquisitions of utility systems and other, net
Additions to funds restricted for construction activity
Release of funds previously restricted for construction activity
Net proceeds from the sale of utility system and other assets
Proceeds from note receivable
Investment in joint venture
Investing cash flows used in continuing operations
Investing cash flows from (used in) discontinued operations, net
Net cash flows used in investing activities
Cash flows from financing activities:
Customers’ advances and contributions in aid of construction
Repayments of customers’ advances
Net (repayments) proceeds of short-term debt
Proceeds from long-term debt
Repayments of long-term debt
Change in cash overdraft position
Proceeds from issuing common stock
Proceeds from exercised stock options
Stock-based compensation windfall tax benefits
Repurchase of common stock
Dividends paid on common stock
Financing cash flows from (used in) continuing operations
Financing cash flows from discontinued operations, net
Net cash flows from (used in) financing activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 Basis of Presentation
The accompanying consolidated balance sheets and statements of capitalization of Aqua America, Inc. and subsidiaries (the “Company”) at September 30, 2012, the consolidated statements of net income and comprehensive income for the nine and three months ended September 30, 2012 and 2011, the consolidated statements of cash flow for the nine months ended September 30, 2012 and 2011, and the consolidated statement of equity for the nine months ended September 30, 2012, are unaudited, but reflect all adjustments, consisting of only normal recurring accruals, which are, in the opinion of management, necessary to present fairly the consolidated financial position, the consolidated changes in equity, the consolidated results of operations, and the consolidated cash flow for the periods presented. Because they cover interim periods, the statements and related notes to the financial statements do not include all disclosures and notes normally provided in annual financial statements and, therefore, should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The results of operations for interim periods may not be indicative of the results that may be expected for the entire year. The December 31, 2011 consolidated balance sheet data presented herein was derived from the Company’s December 31, 2011 audited consolidated financial statements, but does not include all disclosures and notes normally provided in annual financial statements. Certain prior period amounts have been reclassified to conform to the reporting of discontinued operations (see Note 4).
Note 2 Goodwill
The following table summarizes the changes in the Company’s goodwill, by business segment:
Goodwill acquired
Reclassifications to utility plant acquisition adjustment
Included within the Company’s assets of discontinued operations held for sale as of December 31, 2011 is $12,316 of goodwill, and as of September 30, 2012 there was no goodwill associated with the Company’s assets of discontinued operations held for sale.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The reclassification of goodwill to utility plant acquisition adjustment in the table above results from a mechanism approved by the applicable public utility commission. The mechanism provides for the transfer over time, and the recovery through customer rates, of goodwill associated with certain acquisitions upon achieving certain objectives.
As of July 31, 2012, management performed its annual test of goodwill for impairment, in conjunction with the timing of the Company’s annual five-year financial plan. Based on the Company’s comparison of the estimated fair value of its reporting units to their respective carrying amounts, management concluded that the estimated fair value of each reporting unit, which has goodwill recorded, was substantially in excess of the reporting unit’s carrying amount.
Note 3 Acquisitions
As part of the Company’s growth-through-acquisition strategy, in July 2011, the Company entered into a definitive agreement with American Water Works Company, Inc. (“American Water”) to purchase all of the stock of the subsidiary that holds American Water’s regulated water and wastewater operations in Ohio. American Water’s Ohio operations served approximately 57,000 customers. On May 1, 2012, the Company completed its acquisition of American Water’s water and wastewater operations in Ohio. The total purchase price at closing consisted of $101,083 in cash plus certain assumed liabilities, including debt of $14,281, which is subject to certain post-closing adjustments. The transaction has been accounted for as a business combination. The Company has included the results of its acquisition in Ohio in our consolidated financial statements as part of our Regulated segment since the date of acquisition. The proforma impact of the Company’s Ohio acquisition was not material to our results of operations for the quarters and nine months ended September 30, 2012 and 2011, respectively, and to our financial condition as of September 30, 2012. The preliminary purchase price allocation is as follows:
Property, plant and equipment, net
Current assets
Other long-term assets
Total assets acquired
Current liabilities
Other long-term liabilities
Total liabilities assumed
Net assets acquired
10
Note 4 Discontinued Operations and Other Dispositions
Discontinued Operations – In September 2012, the Company began to market for sale its water and wastewater operations in Florida, which serves approximately 38,000 customers, and the Company’s waste water treatment facility in Georgia. The Company has accounted for these operations as business held for sale. The sale of the Company’s water and wastewater operations in Florida and Georgia will conclude the Company’s operations in these states.
In July 2011, the Company entered into a definitive agreement with Connecticut Water Service, Inc. to sell its operations in Maine, which served approximately 16,000 customers, for cash at closing plus certain assumed liabilities, including debt of $17,364. On January 1, 2012, the Company completed the sale for net proceeds of $36,870, and recognized a gain on sale of $17,699 ($10,821 after-tax). Beginning in the third quarter of 2011, the Company recognized income tax expense of $4,008 for the additional deferred tax liabilities that arose from the difference between the stock and tax basis of the Company’s investment in its Aqua Maine subsidiary.
In July 2011, the Company entered into a definitive agreement with American Water to sell its operations in New York for its book value at closing plus certain assumed liabilities, including debt of approximately $23,000. On May 1, 2012, the Company completed the sale for net proceeds of $39,274 at closing, which is subject to certain post-closing adjustments.
During the second quarter of 2012, the Company recognized a loss on sale of $2,736 ($1,874 after-tax), resulting from charges incurred from the sale. Beginning in the third quarter of 2011, the Company recognized income tax expense of $3,245 for the additional deferred tax liabilities that arise from the difference between the stock and tax basis of the Company’s investment in its Aqua New York subsidiary. The Company’s New York operations served approximately 51,000 customers.
The operating results, cash flows, and financial position of the Company’s subsidiaries named above, during the periods owned, have been presented in the Company’s consolidated statements of net income, consolidated statements of cash flow, and consolidated balance sheets as discontinued operations. These subsidiaries were included in the Company’s “Regulated” segment.
11
A summary of discontinued operations presented in the consolidated statements of net income include the following:
Total operating expenses
Other (income) expense:
Gain on sale
Loss on sale
Other expense, net
The assets and liabilities of discontinued operations presented in the consolidated balance sheets include the following:
Other assets
Other liabilities
Net assets
12
Other Dispositions – The following dispositions have not been presented as discontinued operations in the Company’s consolidated financial statements as the Company does not believe that disclosure of the following disposed water and wastewater utility systems as discontinued operations is meaningful to the reader of the financial statements for making investment decisions either individually or in the aggregate. The gains disclosed below are reported in the consolidated statements of net income as a reduction to operations and maintenance expense.
In May 2012, the Company sold a water and wastewater utility system in Florida for net proceeds of $2,505. The sale resulted in the recognition of a gain on the sale of these assets, net of expenses, of $328. The utility systems represented approximately 0.05% of the Company’s total assets.
In June 2011, the Company sold a water and wastewater utility system in North Carolina for net proceeds of $4,106. The sale resulted in the recognition of a gain on the sale, net of expenses, of $2,692. In May 2011, the Company sold its regulated water and wastewater operations in Missouri for net proceeds of $3,225. The sale resulted in the recognition of a gain on the sale of these assets, net of expenses, of $280. This sale of the Company’s Missouri operations concluded its regulated utility operations in Missouri. In January 2011, the Company sold a water and wastewater utility system in Texas for net proceeds of $3,118. The sale resulted in the recognition of a gain on the sale of these assets, net of expenses, of $2,452. Theses utility systems represented approximately 0.11% of the Company’s total assets.
The City of Fort Wayne, Indiana (“the City”) has authorized the acquisition by eminent domain of the northern portion of the utility system of one of the Company’s operating subsidiaries in Indiana. In January 2008, the Company reached a settlement with the City to transition the northern portion of the system in February 2008 upon receipt of the City’s initial valuation payment of $16,911. The settlement agreement specifically stated that the final valuation of the northern portion of the Company’s system will be determined through a continuation of the legal proceedings that were filed challenging the City’s valuation. On February 12, 2008, the Company turned over the northern portion of the system to the City upon receipt of the initial valuation payment. The proceeds received by the Company are in excess of the book value of the assets relinquished. No gain has been recognized due to the contingency over the final valuation of the assets. The net book value of the assets relinquished has been removed from the consolidated balance sheet and the difference between the net book value and the initial payment received has been deferred and is recorded in other accrued liabilities on the Company’s consolidated balance sheet. Once the contingency is resolved and the asset valuation is finalized, through the finalization of the litigation between the Company and the City of Fort Wayne, the amounts deferred will be recognized in the Company’s consolidated statement of net income. On March 16, 2009, oral argument was held on certain procedural aspects with respect to the valuation evidence that may be presented and whether the Company is entitled to a jury trial. On October 12, 2010, the Wells County Indiana Circuit Court ruled that the Company is not entitled to a jury trial, and that the Wells County judge should review the City of Fort Wayne Board of Public Works’ assessment based upon a “capricious, arbitrary or an abuse of discretion” standard.
13
The Company disagreed with the Court’s decision and appealed the Wells County Indiana Circuit Court’s decision to the Indiana Court of Appeals. On January 13, 2012, the Indiana Court of Appeals reached a decision upholding the Wells County Indiana Circuit Court decision. On February 10, 2012, the Company filed a petition for transfer requesting that the Indiana Supreme Court review the matter. The Supreme Court of Indiana accepted transfer and the matter is pending the Court’s decision. The Company continues to evaluate its legal options with respect to this decision. Depending upon the outcome of all of the legal proceedings the Company may be required to refund a portion of the initial valuation payment, or may receive additional proceeds. The northern portion of the utility system relinquished represents approximately 0.40% of the Company’s total assets.
Note 5 Fair Value of Financial Instruments
The Company follows the Financial Accounting Standards Board’s (“FASB”) accounting guidance for fair value measurements and disclosures, which defines fair value and establishes a framework for using fair value to measure assets and liabilities. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:
Level 1: unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access;
Level 2: inputs other than Level 1 that are observable, either directly or indirectly, such as quoted market prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in non-active markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; or
Level 3: inputs that are unobservable and significant to the fair value measurement.
The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. There have been no changes in the valuation techniques used to measure fair value for the quarter ended September 30, 2012.
Financial instruments are recorded at carrying value in the financial statements and approximate fair value as of the dates presented. The fair value of these instruments is disclosed below in accordance with current accounting guidance related to financial instruments.
14
The fair value of funds restricted for construction activity and loans payable are determined based on their carrying amount and utilizing level 1 methods and assumptions. As of September 30, 2012 and December 31, 2011, the carrying amount of the Company’s funds restricted for construction activity was $35,575 and $88,905, which equates to their estimated fair value. As of September 30, 2012 and December 31, 2011, the carrying amount of the Company’s loans payable was $97,650 and $107,771, which equates to their estimated fair value. The fair value of cash and cash equivalents, which is comprised of a money market fund, is determined based on the net asset value per unit utilizing level 2 methods and assumptions. As of September 30, 2012 and December 31, 2011, the carrying amounts of the Company’s cash and cash equivalents was $6,122 and $8,204, which equates to their fair value.
The carrying amounts and estimated fair values of the Company’s long-term debt is as follows:
Carrying Amount
Estimated Fair Value
Included in the carrying amount of the Company’s long-term debt as of December 31, 2011, is long-term debt associated with discontinued operations of $40,662. The fair value of the Company’s long-term debt as of December 31, 2011 for its discontinued operations is $43,068.
The fair value of long-term debt has been determined by discounting the future cash flows using current market interest rates for similar financial instruments of the same duration utilizing level 2 methods and assumptions. The Company’s customers’ advances for construction and related tax deposits have a carrying value of $75,906 as of September 30, 2012, and $66,198 as of December 31, 2011. Their relative fair values cannot be accurately estimated because future refund payments depend on several variables, including new customer connections, customer consumption levels, and future rate increases. Portions of these non-interest bearing instruments are payable annually through 2027 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.
15
Note 6 Net Income per Common Share
Basic net income per common share is based on the weighted average number of common shares outstanding. Diluted net income per common share is based on the weighted average number of common shares outstanding and potentially dilutive shares. The dilutive effect of employee stock-based compensation is included in the computation of diluted net income per common share. The dilutive effect of stock-based compensation is calculated using the treasury stock method and expected proceeds upon exercise or issuance of the stock-based compensation. The following table summarizes the shares, in thousands, used in computing basic and diluted net income per common share:
Average common shares outstanding during the period for basic computation
Dilutive effect of employee stock-based compensation
Average common shares outstanding during the period for diluted computation
For the nine and three months ended September 30, 2012, employee stock options to purchase 427,952 shares of common stock, were excluded from the calculations of diluted net income per share as the calculated proceeds from the options’ exercise were greater than the average market price of the Company’s common stock during these periods. For the nine and three months ended September 30, 2011, employee stock options to purchase 933,800 shares of common stock, were excluded from the calculations of diluted net income per share as the calculated proceeds from the options’ exercise were greater than the average market price of the Company’s common stock during these periods.
Note 7 Capitalization
In June 2012, the Company issued $50,000 of senior unsecured notes due in 2027 with an interest rate of 3.57%. In May 2012, in connection with the Company’s acquisition in Ohio, the Company assumed $14,281 of long-term debt, which includes a purchase accounting fair value adjustment of $3,578, increasing the carrying value of the long-term debt. The long-term debt assumed has maturity dates ranging from 2026 to 2029 and interest rates ranging from 4.14% to 7.18%.
On March 23, 2012, the Company entered into a five-year $150,000 unsecured revolving credit facility with three banks that expires in March 2017. Included within this facility is a $15,000 sublimit for daily demand loans. Funds borrowed under this facility are classified as long-term debt and are used to provide working capital. The Company’s $150,000 unsecured revolving credit facility replaced the Company’s prior $95,000 unsecured revolving credit facility, which expired in May 2012.
16
In February 2012, the Company renewed its universal shelf registration statement, which expired in December 2011, through a filing with the Securities and Exchange Commission (“SEC”), which allows for the potential future offer and sale by the Company, from time to time, in one or more public offerings, of an indeterminate amount of the Company’s common stock, preferred stock, debt securities, and other securities specified therein at indeterminate prices. The Company’s Board of Directors has authorized the Company to issue up to $500,000 of the Company’s common stock, preferred stock, debt securities, and other securities specified therein under this universal shelf registration statement. No issuances have been completed to date under this shelf registration statement.
Note 8 Stock-based Compensation
Under the Company’s 2009 Omnibus Equity Compensation Plan (the “2009 Plan”), as approved by the Company’s shareholders to replace the 2004 Equity Compensation Plan (the “2004 Plan”), stock options, stock units, stock awards, stock appreciation rights, dividend equivalents, and other stock-based awards may be granted to employees, non-employee directors, and consultants and advisors. The 2009 Plan authorizes 5,000,000 shares for issuance under the plan. A maximum of 50% of the shares available for issuance under the 2009 Plan may be issued as restricted stock and the maximum number of shares that may be subject to grants under the Plan to any one individual in any one year is 200,000. Awards under the 2009 Plan are made by a committee of the Board of Directors. At September 30, 2012, 3,894,179 shares underlying stock-based compensation awards were still available for grants under the 2009 Plan. No further grants may be made under the 2004 Plan.
In the first quarter of 2012, the Company recognized a tax benefit of $588 associated with stock-based compensation that vested or was exercised during the fiscal year ended December 31, 2011, which, as a result of the Company’s 2011 Federal cumulative net operating loss, was not recognized in 2011, because the deduction did not reduce income taxes payable. The recognition in the first quarter of 2012 of the tax benefit resulted in a reduction to income taxes payable and an increase in stockholders’ equity.
Performance Share Units – A performance share unit (“PSU”) represents the right to receive a share of the Company’s common stock if specified performance goals are met over the three year performance period specified in the grant, subject to certain exceptions through the respective vesting period, which range from two to three years. Each grantee is granted a target award of PSUs, and may earn between 0% and 200% of the target amount depending on the Company’s performance against the performance goals. The following table provides compensation costs for stock-based compensation related to performance share units:
Stock-based compensation for performance share units within operations and maintenance expenses
17
The following table summarizes nonvested PSU transactions for the nine months ended September 30, 2012:
Nonvested share units at beginning of period
Granted
Performance criteria adjustment
Forfeited
Vested
Share unit awards issued
Nonvested share units at end of period
The fair value of PSUs was estimated at the grant date based on the probability of satisfying the performance conditions associated with the PSUs using the Monte Carlo valuation method. The per unit weighted-average fair value at the date of grant for PSUs granted during the nine months ended September 30, 2012 and 2011 was $23.89 and $24.38, respectively. The fair value of each PSU grant is amortized monthly into compensation expense on a straight-line basis over their respective vesting periods, which range from 24 to 36 months. The accrual of compensation costs is based on our estimate of the final expected value of the award, and is adjusted as required. The Company assumes that forfeitures will be minimal, and recognizes forfeitures as they occur, which results in a reduction in compensation expense. The recording of compensation expense for PSUs has no impact on net cash flows.
Restricted Stock Units – A restricted stock unit (“RSU”) represents the right to receive a share of the Company’s common stock. RSUs are eligible to be earned at the end of a specified restricted period, generally three years, beginning on the date of grant. The Company assumes that forfeitures will be minimal, and recognizes forfeitures as they occur, which results in a reduction in compensation expense. The following table provides compensation costs for stock-based compensation related to restricted stock units:
Stock-based compensation for restricted stock units within operations and maintenance expenses
18
The following table summarizes nonvested RSU transactions for the nine months ended September 30, 2012:
Nonvested stock units at beginning of period
Nonvested stock units at end of period
The per unit weighted-average fair value at the date of grant for RSUs granted during the nine months ended September 30, 2012 and 2011 was $22.49 and $22.21, respectively
Stock Options – The fair value of stock options is estimated at the grant date using the Black-Scholes option-pricing model. The following table provides compensation costs for stock-based compensation related to stock options granted in prior periods:
Stock-based compensation for stock options within operations and maintenance expenses
Income tax benefit
There were no stock options granted during the nine months ended September 30, 2012 or 2011.
19
The following table summarizes stock option transactions for the nine months ended September 30, 2012:
Options:
Outstanding at beginning of period
Expired
Exercised
Outstanding at end of period
Exercisable at end of period
Restricted Stock –During the nine and three months ended September 30, 2012 and 2011, the Company recorded stock-based compensation related to restricted stock awards as a component of operations and maintenance expense as follows:
Stock-based compensation for restricted stock within operations and maintenance expenses
The following table summarizes nonvested restricted stock transactions for the nine months ended September 30, 2012:
Nonvested shares at beginning of period
20
Note 9 Pension Plans and Other Postretirement Benefits
The Company maintains qualified defined benefit pension plans, nonqualified pension plans and other postretirement benefit plans for certain of its employees. The net periodic benefit cost is based on estimated values and an extensive use of assumptions about the discount rate, expected return on plan assets, the rate of future compensation increases received by the Company’s employees, mortality, turnover, and medical costs. The following tables provide the components of net periodic benefit costs:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Amortization of actuarial loss
Capitalized costs
Settlement charge
Curtailment (credit) charge
Less discontinued operations
Net periodic benefit cost
Amortization of transition obligation
Amortization of regulatory asset
Curtailment charge
21
The Company made cash contributions of $15,370 to its defined benefit pension plans during the first six months of 2012, which represented the completion of the Company’s 2012 cash contributions. In addition, the Company expects to make cash contributions of $2,685 for the funding of its other postretirement benefit plans during the remainder of 2012.
Note 10 Water and Wastewater Rates
During the first nine months of 2012, the Company’s operating divisions in Texas, Ohio, Illinois, New Jersey, Pennsylvania (wastewater) Virginia, and Indiana were granted base rate increases designed to increase total operating revenues on an annual basis by $17,923.
On June 7, 2012, the Pennsylvania Public Utility Commission granted the Company’s operating subsidiary in Pennsylvania (“Aqua Pennsylvania”) a water rate increase designed to increase total operating revenues by $16,700, on an annualized basis. The rates in effect at the time of the filing included $27,449 in Distribution System Improvement Charges (“DSIC”) or 7.5% above prior base rates. Consequently, the total base rates increased by $44,149 since the last base rate increase and the DSIC was reset to zero. In addition, the rate case settlement provides for the flow-through accounting treatment of certain income tax benefits if the Company elects a change to its tax accounting method to permit the expensing of selected utility asset improvement costs that are presently being capitalized and depreciated for tax purposes (the “Repair Election”). The Company is presently evaluating the Repair Election for adoption in Aqua Pennsylvania in 2012 or 2013.
During the first nine months of 2012, the Company’s operating division in Pennsylvania received infrastructure rehabilitation surcharges of $2,764. Infrastructure rehabilitation surcharges are capped as a percentage of base rates, generally at 5% to 9% of base rates, and are reset to zero when new base rates that reflect the costs of those additions become effective or when a utility’s earnings exceed a regulatory benchmark. The Company’s other subsidiaries received infrastructure rehabilitation surcharges of $1,390 during the first nine months of 2012. In June 2012, the New Jersey Board of Public Utilities approved a rulemaking to implement an infrastructure rehabilitation surcharge for regulated water utilities; as a result, the Company’s operating subsidiary in New Jersey is in the process of implementing an infrastructure rehabilitation surcharge.
In February 2012, two of the Company’s operating divisions in Texas began to bill interim rates in accordance with authorization from the Texas Commission on Environmental Quality (the “TCEQ”). The additional revenue billed and collected prior to the TCEQ’s final ruling is subject to refund based on the outcome of the rate case. As of September 30, 2012, the Company had billed revenue of $3,419, which is subject to refund based on the outcome of the TCEQ’s final ruling. Based on the Company’s review of the present circumstances, a reserve of $1,197 has been established for the billings to date.
In October 2010, one of the Company’s operating divisions in Texas began to bill interim rates in accordance with authorization from the TCEQ. The additional revenue billed and collected prior to the TCEQ’S final ruling is subject to refund based on the outcome of the rate case. The rate case concluded with the issuance of an order on May 20, 2012, and no refunds of revenue previously billed and collected were required.
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Note 11 Taxes Other than Income Taxes
The following table provides the components of taxes other than income taxes:
Property
Capital stock
Gross receipts, excise and franchise
Payroll
Total taxes other than income
Note 12 Segment Information
The Company has identified twelve operating segments and has one reportable segment named the “Regulated” segment. The reportable segment is comprised of ten operating segments for the Company’s water and wastewater regulated utility companies which are organized by the states where we provide these services. In addition, two segments are not quantitatively significant to be reportable and are comprised of the businesses that provide on-site septic tank pumping, sludge hauling services and certain other non-regulated water and wastewater services, and serving the clean water needs of firms in the shale oil and gas exploration industry. These segments are included as a component of “Other” in the tables below. Also included in “Other” are corporate costs that have not been allocated to the Regulated segment and intersegment eliminations.
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The following table presents the Company’s segment information for its continuing operations:
Operations and maintenance expense
Interest expense, net of AFUDC
Income tax expense (benefit)
Income (loss) from continuing operations
Capital expenditures
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Total assets:
Regulated
Other and eliminations
Consolidated
Included within the Company’s regulated segment total assets for September 30, 2012 and December 31, 2011 are total assets of discontinued operations of $85,503 and $263,061, respectively.
Note 13 Commitments and Contingencies
The Company is routinely involved in various disputes, claims, lawsuits and other regulatory and legal matters, including both asserted and unasserted legal claims, in the ordinary course of business. The status of each such matter, referred to herein as a loss contingency, is reviewed and assessed in accordance with applicable accounting rules regarding the nature of the matter, the likelihood that a loss will be incurred, and the amounts involved. As of September 30, 2012, the aggregate amount of $12,254 is accrued for loss contingencies and is reported in the Company’s consolidated balance sheet as other accrued liabilities and other liabilities. These accruals represent management’s best estimate of probable loss (as defined in the accounting guidance) for loss contingencies or the low end of a range of losses if no single probable loss can be estimated. For some loss contingencies, the Company is unable to estimate the amount of the probable loss or range of probable losses. While the final outcome of these loss contingencies cannot be predicted with certainty, and unfavorable outcomes could negatively impact the Company, at this time in the opinion of management, the final resolution of these matters are not expected to have a material adverse effect on the Company’s financial position, results of operations or cash flows. Further, the Company has insurance coverage for certain of these loss contingencies, and as of September 30, 2012, estimates that approximately $1,884 of the amount accrued for these matters are probable of recovery through insurance, which amount is also reported in the Company’s consolidated balance sheet as deferred charges and other assets, net.
Note 14 Income Taxes
During the nine and three months ended September 30, 2012, the Company utilized $76,593 and $24,611, respectively of its Federal net operating loss (“NOL”) carryfoward that was recognized in 2011 and 2010 to reduce its 2012 Federal tax liability. In addition, during the nine and three months ended September 30, 2012, the Company utilized $25,111 and $8,909, respectively of its state NOL carryfoward that was recognized in 2011 and 2010 to reduce its 2012 state tax liability. As of September 30, 2012, the balance of the Company’s Federal NOL is $20,665. The Company believes its Federal NOL carrryfoward is more likely than not to be recovered and requires no valuation allowance.
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As of September 30, 2012, the balance of the Company’s state NOL is $101,426, a portion of which is offset by a valuation allowance of $9,068 because the Company does not believe the NOLs are more likely than not to be realized. The Company’s Federal and state NOL carryfowards do not begin to expire until 2030 and 2021, respectively.
Note 15 Recent Accounting Pronouncements
In September 2011, the FASB issued revised accounting guidance for accounting for intangible assets, which is intended to reduce the cost and complexity of the annual goodwill impairment test by permitting an entity the option of performing a qualitative assessment to determine whether further impairment testing is necessary. The revised guidance is effective for annual periods beginning after December 15, 2011. In the third quarter of 2012, the Company adopted the provisions of the revised guidance for its 2012 annual goodwill impairment test, and the adoption of the revised guidance did not have an impact on the Company’s consolidated results of operations or consolidated financial position.
In May 2011, the FASB issued updated accounting guidance related to fair value measurements and disclosures that result in common fair value measurements and disclosures between U.S. Generally Accepted Accounting Principles (“GAAP”) and International Financial Reporting Standards. This new guidance amends current fair value measurement and disclosure guidance to increase transparency around valuation inputs and investment categorization. This guidance is effective for interim and annual periods beginning on January 1, 2012 and is required to be applied prospectively. The adoption of this guidance did not have a significant impact on the Company’s consolidated results of operations or consolidated financial position.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-looking Statements
This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Quarterly Report contain, in addition to historical information, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements address, among other things: our belief in our ability to renew our short-term lines of credit; the impact and the actions we may need to take if we are unable to obtain sufficient capital; the projected impact of various legal proceedings; the projected effects of recent accounting pronouncements; prospects, plans, objectives, expectations and beliefs of management, as well as information contained in this report where statements are preceded by, followed by or include the words “believes,” “expects,” “anticipates,” “plans,” “future,” “potential,” “probably,” “predictions,”“intends,” “will,” “continue” or the negative of such terms or similar expressions. Forward-looking statements are based on a number of assumptions concerning future events, and are subject to a number of risks, uncertainties and other factors, many of which are outside our control, which could cause actual results to differ materially from those expressed or implied by such statements. These risks and uncertainties include, among others: the effects of regulation, abnormal weather, changes in capital requirements and funding, acquisitions, changes to the capital markets, and our ability to assimilate acquired operations, as well as those risks, uncertainties and other factors discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 under the captions “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in such report. As a result, readers are cautioned not to place undue reliance on any forward-looking statements. We undertake no obligation to update or revise forward-looking statements, whether as a result of new information, future events or otherwise.
General Information
Nature of Operations - Aqua America, Inc. (“we” or “us”), a Pennsylvania corporation, is the holding company for regulated utilities providing water or wastewater services to what we estimate to be approximately 3 million people in Pennsylvania, Ohio, North Carolina, Illinois, Texas, New Jersey, Florida, Indiana, Virginia, and Georgia. Our largest operating subsidiary, Aqua Pennsylvania, Inc., provides water or wastewater services to approximately one-half of the total number of people we serve, who are located in the suburban areas in counties north and west of the City of Philadelphia and in 25 other counties in Pennsylvania. Our other subsidiaries provide similar services in 9 other states.
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FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
In July 2011, we entered into a definitive agreement to sell our operations in Maine, which served approximately 16,000 customers. The sale of our utility in Maine closed in January 2012, concluding our regulated operations in Maine. Also, in July 2011, we entered into a definitive agreement to purchase all of American Water Works Company, Inc.’s regulated operations in Ohio (the “Ohio acquisition”), which served approximately 57,000 customers, and to simultaneously sell our regulated water and wastewater operations in New York, which served approximately 51,000 customers. In May 2012, we completed this transaction, concluding our regulated operations in New York. The Ohio acquisition was financed by short-term debt. The proceeds from the dispositions of our operations in New York and Maine were used to paydown a portion of our short-term debt and other general corporate purposes. In September 2012, we began to market for sale our water and wastewater operations in Florida, which serves approximately 38,000 customers, and our waste water treatment facility in Georgia. We have accounted for the sale of our water and wastewater operations in New York and Maine and planned disposition of our water and wastewater operations in Florida and Georgia as discontinued operations. In addition, we provide water and wastewater service through operating and maintenance contracts with municipal authorities and other parties close to our utility companies’ service territories, as well as sludge hauling, septage and grease services, backflow prevention services, and certain other non-regulated water and wastewater services.
Aqua America, Inc., which prior to its name change in 2004 was known as Philadelphia Suburban Corporation, was formed in 1968 as a holding company for its primary subsidiary, Aqua Pennsylvania, Inc., formerly known as Philadelphia Suburban Water Company. Since the early 1990s, we have embarked on a growth-through-acquisition strategy focused on water and wastewater operations. Our most significant transactions to date have been the merger with Consumers Water Company in 1999, the acquisition of the regulated water and wastewater operations of AquaSource, Inc. in 2003, the acquisition of Heater Utilities, Inc. in 2004, and the acquisition of American Water Works Company, Inc.’s regulated operations in Ohio in 2012. Since the early 1990s, our business strategy has been primarily directed toward the regulated water and wastewater utility industry and has extended our regulated operations from southeastern Pennsylvania to include operations in nine other states.
Beginning in 2010, and continuing into 2012, we are following a portfolio rationalization strategy to focus in areas where we have critical mass and to prune operations that do not fit into our future growth plans. In 2012 we sold our operations in Maine and New York, in 2011 we sold our operations in Missouri, and in 2010 we sold our operations in South Carolina. In connection with the sale of our New York and Missouri operations, we acquired additional utility systems (and customers) in Ohio and Texas.
In 2011, one of our subsidiaries entered into a joint venture with a third-party investor for the construction and operation of a private pipeline system to supply fresh water to certain natural gas well drilling operations in Pennsylvania. The operation of the private pipeline system commenced in the second quarter of 2012 and marks an expansion of our growth venture in serving the clean water needs of drillers in the shale oil and gas drilling industry.
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Financial Condition
During the first nine months of 2012, we had $262,832 of capital expenditures, issued $179,166 of long-term debt, and repaid debt and made sinking fund contributions and other loan repayments of $109,265. The capital expenditures were related to improvements to treatment plants, new and rehabilitated water mains, tanks, hydrants, and service lines, well and booster improvements, and other enhancements and improvements. The issuance of $179,166 of long-term debt was comprised principally of the funds borrowed under our revolving credit facility of $114,000 and the proceeds received from the June 2012 issuance of senior unsecured notes payable of $50,000, which were utilized to fund the Company’s capital expenditures. In May 2012, in connection with our acquisition in Ohio, we assumed $14,281 of long-term debt, which includes a purchase accounting fair value adjustment of $3,578, increasing the carrying value of the long-term debt.
At September 30, 2012, we had $6,122 of cash and cash equivalents compared to $8,204 at December 31, 2011. During the first nine months of 2012, we used the proceeds from internally generated funds, the sale of our Maine subsidiary, the sale of other assets, and the sale or issuance of common stock through our equity compensation plan and dividend reinvestment plan, to fund the cash requirements discussed above and to pay dividends.
On March 23, 2012, Aqua America, Inc. entered into a five-year $150,000 unsecured revolving credit facility with three banks that expires in March 2017. As of September 30, 2012, funds available for borrowing under this facility were $48,786. The Company’s $150,000 unsecured revolving credit facility replaced the Company’s prior $95,000 unsecured revolving credit facility, which expired in May 2012. At September 30, 2012, we had short-term lines of credit of $160,500, of which $62,850 was available. One of our short-term lines of credit is an Aqua Pennsylvania $100,000 364-day unsecured revolving credit facility with three banks, which is used to provide working capital, and as of September 30, 2012, $14,791 was available.
Our short-term lines of credit of $160,500 are subject to renewal on an annual basis. Although we believe we will be able to renew these facilities, there is no assurance that they will be renewed, or what the terms of any such renewal will be. The United States credit and liquidity crisis that occurred in 2008 and 2009 caused substantial volatility in capital markets, including credit markets and the banking industry, generally reduced the availability of credit from financing sources, and could reoccur in the future. If in the future, our credit facilities are not renewed or our short-term borrowings are called for repayment, we would have to seek alternative financing sources; however, there can be no assurance that these alternative financing sources would be available on terms acceptable to us. In the event we are not able to obtain sufficient capital, we may need to reduce our capital expenditures and our ability to pursue acquisitions that we may rely on for future growth could be impaired.
The Company’s consolidated balance sheet historically has had a negative working capital position whereby routinely our current liabilities exceed our current assets. Management believes that internally generated funds along with existing credit facilities and the proceeds from the issuance of long-term debt and common stock will be adequate to provide sufficient working capital to maintain normal operations and to meet our financing requirements for at least the next twelve months.
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In February 2012, we renewed our universal shelf registration statement, which expired in December 2011, through a filing with the SEC, which allows for the potential future offer and sale by the Company, from time to time, in one or more public offerings, of an indeterminate amount of our common stock, preferred stock, debt securities, and other securities specified therein at indeterminate prices. The Company’s Board of Directors has authorized the Company to issue up to $500,000 of our common stock, preferred stock, debt securities, and other securities specified therein under this universal shelf registration statement. No issuances have been completed to date under this shelf registration statement.
On June 7, 2012, the Company’s Pennsylvania operating subsidiary (“Aqua Pennsylvania”) reached a settlement agreement in its rate filing with the Pennsylvania Public Utility Commission, which in addition to a water rate increase, provides for the flow-through accounting treatment of certain income tax benefits if the Company elects a change to its tax accounting method to permit the expensing of selected utility asset improvement costs that are presently being capitalized and depreciated for tax purposes (the “Repair Election”). The Company is presently evaluating the Repair Election for adoption in Aqua Pennsylvania in 2012 or 2013. If adopted, prior to the receipt of Aqua Pennsylvania’s next rate order, the change will result in a substantial reduction in income tax expense and greater net income and cash flow, and as a result will allow the Company to discontinue any Distribution System Improvement Charges and lengthen the amount of time until the next Aqua Pennsylvania rate case is filed.
Results of Operations
Analysis of First Nine Months of 2012 Compared to First Nine Months of 2011
Unless specifically noted, the following discussion of the Company’s results of operations for the first nine months of 2012 refers to the Company’s results of operations from continuing operations.
Revenues increased $49,781 or 9.6% primarily due to additional revenues associated with increased water and wastewater rates of $26,534, additional water and wastewater revenues of $18,578 associated with a larger customer base due to acquisitions, and an increase in revenues from non-regulated water and wastewater services of $4,210.
Operations and maintenance expenses increased by $9,423 or 5.0% primarily due to operating costs associated with acquired utility systems and other growth ventures of $8,895, the effect of the gain on the sale in the first quarter of 2011 of our utility system in Texas of $2,452 and the gain on sale in the second quarter of 2011 of our utility system in North Carolina of $1,580, an increase in postretirement benefits expenses of $1,977, an increase in stock-based compensation of $1,271, and normal increases in other operating costs. Offsetting these increases was a decrease in water production costs of $5,098, and the effect of the recognition of a regulatory asset resulting from a completed rate case which reduced operations and maintenance expense by $3,356. The decrease in water production costs results primarily from a decrease in the contractual rate of one of our purchased water contracts, and the non-renewal of another purchased water contract.
Depreciation expense increased $5,091 or 6.6% due to the utility plant placed in service since September 30, 2011.
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Amortization decreased $268 primarily due to the effect of additional amortization expense recognized during the first quarter of 2011 of $245 resulting from a rate case adjustment.
Taxes other than income taxes increased by $3,269 or 10.4% primarily due to an increase in excise taxes associated with our acquisition in Ohio, offset by a favorable adjustment related to the gross receipts, excise and franchise taxes return for one of our operating subsidiaries of $824.
Interest expense decreased by $76 or 0.1% primarily due to decreased interest rates on long-term debt and reduced borrowings as a result of the proceeds received from the sale of our operations in Maine.
Allowance for funds used during construction (“AFUDC”) decreased by $2,205 primarily due to a decrease in the average balance of proceeds held from tax-exempt bond issuances that are restricted to funding certain capital projects.
Gain on sale of other assets totaled $826 during the first nine months of 2012 and $475 during the first nine months of 2011. The increase of $351 is principally due to the timing of sales of an equity investment, land and other property.
Equity earnings in joint venture totaled $931 during the first nine months of 2012, and reflect our earnings in serving the clean water needs of firms in the shale oil and gas exploration industry.
Our effective income tax rate was 39.4% during the first nine months of 2012 and 33.3% during the first nine months of 2011. The effective income tax rate increased as a result of the effect of the recognition in 2011 of the net state income tax benefit of $11,193 associated with 100% bonus depreciation for qualifying capital additions. The net state income tax benefit reduced the Company’s 2011 state income tax expense as a result of the flow-through treatment afforded by a state’s regulatory commission.
Income from continuing operations increased by $8,776 or 8.0%, in comparison to the same period in 2011 primarily as a result of the factors described above, which includes the effect of the recognition in 2011 of the net state income tax benefit of $11,193 associated with 100% bonus depreciation for qualifying capital additions. On a diluted per share basis, income from continuing operations increased $0.06 reflecting the change in income from continuing operations and a 0.8% increase in the average number of common shares outstanding. As compared to the first nine months of 2011, income from continuing operations adjusted to exclude the net state income tax benefit associated with 100% bonus depreciation, a non-GAAP financial measure, would have increased by $0.14 per share. The increase in the number of shares outstanding is primarily a result of the additional shares sold or issued through our dividend reinvestment plan and our equity compensation plan.
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Income from discontinued operations increased by $12,168 or $0.09 per diluted share, in comparison to the same period in 2011 primarily as a result of the recognition in the second quarter of 2012 of the gain on sale of our Maine operating subsidiary, net of income taxes, of $10,821, the effect of the income tax expense recognized in the third quarter of 2011 of $7,438 for the additional deferred tax liability that arose from the difference between the stock and tax basis of the Company’s investment in its New York and Maine operating subsidiaries, a reduction in interest expense, net of tax, of $765 as a result of debt assumed in 2012 by the acquirer(s) in the sale of our New York and Maine operating subsidiaries, offset by charges incurred from the disposal of our New York subsidiary of $2,090, and an asset impairment recognized in the third quarter of 2012, net of tax, of $592.
Net income attributable to common shareholders increased by $20,944 or 19.2%, in comparison to the same period in 2011 primarily as a result of the factors described above. On a diluted per share basis, earnings increased $0.14 reflecting the change in net income attributable to common shareholders and a 0.8% increase in the average number of common shares outstanding. The increase in the number of shares outstanding is primarily a result of the additional shares sold or issued through our dividend reinvestment plan and equity compensation plan.
Analysis of Third Quarter of 2012 Compared to Third Quarter of 2011
Unless specifically noted, the following discussion of the Company’s results of operations for the third quarter of 2012 refers to the Company’s results of operations from continuing operations.
Revenues increased $23,482 or 12.3 % primarily due to additional revenues associated with increased water and wastewater rates of $11,046, additional water and wastewater revenues of $10,505 associated with a larger customer base due to acquisitions, and an increase in revenues from non-regulated water and wastewater services of $1,723.
Operations and maintenance expenses increased by $4,766 or 7.2% primarily due to operating costs associated with acquired utility systems and other growth ventures of $5,538, an increase in postretirement benefits expenses of $1,050, an increase in insurance expense of $970, and normal increases in other operating costs. Offsetting these increases was a decrease in water production costs of $1,609. The decrease in water production costs results primarily from a decrease in the contractual rate of one of our purchased water contracts, and the non-renewal of another purchased water contract.
Depreciation expense increased $2,122 or 8.1% due to the utility plant placed in service since September 30, 2011.
Amortization increased $341 primarily due to the amortization of costs associated with, and other costs being recovered in, various rate filings.
Taxes other than income taxes increased by $2,420 or 22.5% primarily due to an increase in excise taxes associated with our acquisition in Ohio.
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AFUDC decreased by $875 primarily due to a decrease in the average balance of proceeds held from tax-exempt bond issuances that are restricted to funding certain capital projects.
Gain on sale of other assets totaled $320 in the third quarter of 2012 and $216 in the third quarter of 2011. The increase of $104 is principally due to the timing of sales of land and other property.
Equity earnings in joint venture totaled $682 during the third quarter of 2012, and reflect our earnings in serving the clean water needs of firms in the shale oil and gas exploration industry.
Our effective income tax rate was 39.3% in the third quarter of 2012 and 35.1% in the third quarter of 2011. The effective income tax rate increased as a result of the effect of the recognition in 2011 of the net state income tax benefit of $3,382 associated with 100% bonus depreciation for qualifying capital additions. The net state income tax benefit reduced the Company’s third quarter 2011 state income tax expense as a result of the flow-through treatment afforded by a state’s regulatory commission.
Income from continuing operations increased by $5,423 or 12.1%, in comparison to the same period in 2011 primarily as a result of the factors described above, which includes the effect of the recognition in 2011 of the net state income tax benefit of $3,382 associated with 100% bonus depreciation for qualifying capital additions. On a diluted per share basis, income from continuing operations increased $0.04 reflecting the change in income from continuing operations and a 1.1% increase in the average number of common shares outstanding. As compared to the third quarter of 2011, income from continuing operations adjusted to exclude the net state income tax benefit associated with 100% bonus depreciation, a non-GAAP financial measure, would have increased by $0.06 per share. The increase in the number of shares outstanding is primarily a result of the additional shares sold or issued through our dividend reinvestment plan and our equity compensation plan.
Income from discontinued operations increased by $4,113 or $0.03 per diluted share, in comparison to the same period in 2011 primarily as a result of the effect of the income tax expense recognized in the third quarter of 2011 of $7,438 for the additional deferred tax liability that arose from the difference between the stock and tax basis of the Company’s investment in its New York and Maine operating subsidiaries, a reduction in interest expense, net of tax, of $350 as a result of debt assumed in 2012 by the acquirer(s) in the sale of our New York and Maine operating subsidiaries, offset by an asset impairment in the third quarter of 2012, net of tax, of $592.
Net income attributable to common shareholders increased by $9,536 or 23.2%, in comparison to the same period in 2011 primarily as a result of the factors described above. On a diluted per share basis, earnings increased $0.06 reflecting the change in net income attributable to common shareholders and a 1.1% increase in the average number of common shares outstanding. The increase in the number of shares outstanding is primarily a result of the additional shares sold or issued through our dividend reinvestment plan and equity compensation plan.
Impact of Recent Accounting Pronouncements
We describe the impact of recent accounting pronouncements in Note 15, Recent Accounting Pronouncements, of the consolidated financial statements.
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Non-Generally Accepted Accounting Principle (“GAAP”) Financial Measures
In addition to reporting “income from continuing operations” and “income from continuing operations per common share”, U.S. GAAP financial measures, we are presenting below “income from continuing operations before net state income tax benefit associated with 100% bonus depreciation” and “income from continuing operations per common share before net state income tax benefit associated with 100% bonus depreciation”, which are considered non-GAAP financial measures. The Company is providing disclosure of the reconciliation of these non-GAAP measures to their most comparable GAAP financial measures. The Company believes that the non-GAAP financial measures provide investors the ability to measure the Company’s financial operating performance excluding the net state income tax benefit associated with 100% bonus depreciation, which is more indicative of the Company’s ongoing performance, and is more comparable to measures reported by other companies. The Company further believes that the presentation of these non-GAAP financial measures is useful to investors as a more meaningful way to compare the Company’s operating performance against its historical financial results and to assess the underlying profitability of our core business. 100% bonus depreciation was in effect for qualifying capital additions placed in service from September 8, 2010 through December 31, 2011.
Income from continuing operations (GAAP financial measure)
Less: Net state income tax benefit associated with 100% bonus depreciation
Income from continuing operations before net state income tax benefit associated with 100% bonus depreciation (Non-GAAP financial measure)
Income from continuing operations per common share (GAAP financial measure):
Income from continuing operations per common share before net state income tax benefit associated with 100% bonus depreciation (Non-GAAP financial measure):
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We are subject to market risks in the normal course of business, including changes in interest rates and equity prices. There have been no significant changes in our exposure to market risks since December 31, 2011. Refer to Item 7A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for additional information.
(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report are effective such that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.
(b) Changes in Internal Control over Financial Reporting
No change in our internal control over financial reporting occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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Part II. Other Information
The City of Fort Wayne, Indiana (the “City”) authorized the acquisition by eminent domain of the northern portion of the utility system of one of the Company’s operating subsidiaries in Indiana. In January 2008, we reached a settlement with the City to transition this portion of the system in February 2008 upon receipt of the City’s initial valuation payment of $16,910,500. The settlement agreement specifically stated that the final valuation of the system will be determined through a continuation of the legal proceedings that were filed challenging the City’s valuation. On February 12, 2008, we turned over the northern portion of the system to the City upon receipt of the initial valuation payment. The proceeds received by the Company are in excess of the book value of the assets relinquished. No gain has been recognized due to the contingency over the final valuation of the assets. The net book value of the assets relinquished has been removed from the consolidated balance sheet and the difference between the net book value and the initial payment received has been deferred and is recorded in other accrued liabilities on the Company’s consolidated balance sheet. Once the contingency is resolved and the asset valuation is finalized, through the finalization of the litigation between the Company and the City of Fort Wayne, the amounts deferred will be recognized in the Company’s consolidated income statement. On March 16, 2009, oral argument was held before the Allen County Circuit Court on certain procedural aspects with respect to the valuation evidence that may be presented and whether we are entitled to a jury trial. On October 12, 2010, the Wells County Indiana Circuit Court ruled that the Company is not entitled to a jury trial, and that the Wells County judge should review the City of Fort Wayne Board of Public Works’ assessment based upon a “capricious, arbitrary or an abuse of discretion” standard. The Company appealed the Wells County Indiana Circuit Court’s decision to the Indiana Court of Appeals. On January 13, 2012, the Indiana Court of Appeals reached a decision upholding the Wells County Indiana Circuit Court decision. On February 10, 2012, the Company filed a petition for transfer requesting that the Indiana Supreme Court review the matter. The Supreme Court of Indiana accepted transfer and the matter is pending the Court’s decision. The Company continues to evaluate its legal options with respect to this decision. Depending upon the outcome of all of the legal proceedings we may be required to refund a portion of the initial valuation payment, or may receive additional proceeds. The northern portion of the system relinquished represented approximately 0.40% of Aqua America’s total assets.
One of the Company’s subsidiaries, South Haven Sewer Works, acquired in 2008 has been operating under a Consent Decree with the EPA and the United States Department of Justice entered into in 2003. The Consent Decree addresses the elimination of sanitary sewer overflows from the subsidiary’s sewer system. Although substantial improvements to the system have been made to significantly reduce the number of sanitary sewer overflows at the sewer system since the Company’s acquisition of the subsidiary, the EPA and Department of Justice proposed on May 11, 2010, a revised Consent Decree, including new dates for completing work to address sanitary sewer overflows in the system and a proposed civil penalty of $364,000 for purported sanitary sewer overflow violations since the date of the original Consent Decree, which was entered into by the original owner. The Company’s subsidiary has contested the appropriateness of calculating the proposed penalty based on sanitary sewer violations occurring prior to the acquisition of the subsidiary and the amount of the proposed penalty. The Company continues to negotiate a proposed modification with the EPA and Department of Justice to resolve the matter. The Company intends to seek indemnification from the seller for this matter for any applicable penalty amounts.
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There have been no material changes to the risks disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011 (“Form 10-K”) under “Part 1, Item 1A – Risk Factors.”
The following table summarizes Aqua America’s purchases of its common stock for the quarter ended September 30, 2012:
Period
July 1 - 31, 2012
August 1 - 31, 2012
September 1 - 30, 2012
Total
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Not applicable
The information required by this Item is set forth in the Exhibit Index hereto which is incorporated herein by reference.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be executed on its behalf by the undersigned thereunto duly authorized.
November 5, 2012
Aqua America, Inc.
Registrant
Nicholas DeBenedictis
Chairman, President and
Chief Executive Officer
David P. Smeltzer
Executive Vice President and
Chief Financial Officer
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EXHIBIT INDEX
Exhibit No.
Description
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