Essential Utilities - 10-Q quarterly report FY2010 Q2

UNITED STATES

WASHINGTON DC  20549

(Mark One)

For the quarterly period ended June 30, 2010

For the transition period from _________________ to _________________

Commission File Number 1-6659

(Exact name of registrant as specified in its charter)

(Registrant's telephone number, including area code)

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TABLE OF CONTENTS

 

AQUA AMERICA, INC. AND SUBSIDIARIES

Part 1 – Financial Information

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands of dollars, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(In thousands, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(In thousands, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CAPITALIZATION

(In thousands of dollars, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EQUITY

(In thousands of dollars)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOW

(In thousands of dollars)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands of dollars, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(In thousands of dollars, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(In thousands of dollars, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(In thousands of dollars, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(In thousands of dollars, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(In thousands of dollars, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(In thousands of dollars, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(In thousands of dollars, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(In thousands of dollars, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(In thousands of dollars, except per share amounts)

(UNAUDITED)

AQUA AMERICA, INC. AND SUBSIDIARIES

 

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 “be lieves,” “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, 2009 under th e 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.

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, New York, Florida, Indiana, Virginia, Maine, Missouri, South Carolina, 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, which 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 13 other states .  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 and backflow prevention services.

AQUA AMERICA, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

 (In thousands of dollars, except per share amounts)

Aqua America, Inc., which prior to its name change in 2004 was known as Philadelphia Suburban Corporation, was formed in 1968 as a holding company for its primary subsidiary, Aqua Pennsylvania, Inc., formerly known as Philadelphia Suburban Water Company.  In the early 1990s we embarked on a growth through acquisition strategy focused on water and wastewater operations. Our most significant transactions to date have been the merger with Consumers Water Company in 1999, the acquisition of the regulated water and wastewater operations of AquaSource, Inc. in 2003, the acquisition of Heater Utilities, Inc. in 2004, and the acquisition of New York Water Service Corporation in 2007.  Since the early 1990s, our business strategy has been primarily directed toward the regulated water and wastewater utility industry and has exte nded our regulated operations from southeastern Pennsylvania to include operations in 13 other states.

During the first six months of 2010, we had $140,767 of capital expenditures, issued $101,329 of long-term debt, repaid debt and made sinking fund contributions and other loan repayments of $50,897, and repaid $4,818 of customer advances for construction.  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 $101,329 of long-term debt was comprised principally of the proceeds received from the June 2010 issuance of senior unsecured notes payable of $70,000, and the funds borrowed under our revolving credit facility of $30,000.

At June 30, 2010, we had $13,112 of cash and cash equivalents compared to $21,869 at December 31, 2009.  During the first six months of 2010, we used the proceeds from internally generated funds, the issuance of long-term debt, the issuance of common stock, the sale of other assets, and available working capital to fund the cash requirements discussed above and to pay dividends.

At June 30, 2010, our $95,000 unsecured revolving credit facility, which expires in May 2012, had $11,521 available for borrowing.  At June 30, 2010, we had short-term lines of credit of $137,000, of which $85,567 was available.  One of our short-term lines of credit is an Aqua Pennsylvania $70,000 364-day unsecured revolving credit facility with two banks, which is used to provide working capital.

Our short-term lines of credit of $137,000 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 started in 2008 which caused substantial volatility in capital markets, including credit markets and the banking industry, has increased the cost and significantly reduced the availability of credit from financing sources, which may continue or worsen 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, although there can be no assurance that these alternative financing sources would be avail able 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.

AQUA AMERICA, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

 (In thousands of dollars, except per share amounts)

The 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 the remainder of the year and the reasonably foreseeable future.

Revenues increased $17,141 or 5.3% primarily due to additional revenues associated with increased water and wastewater rates of $7,879, additional revenues associated with increased infrastructure rehabilitation surcharges of $6,210, increased water consumption as compared to the first six months of 2009, and additional wastewater and water revenues of $1,303 associated with a larger customer base due to acquisitions. The increase in customer water consumption is largely due to favorable weather conditions in our service territories during May and June 2010 that increased water usage.

Operations and maintenance expenses increased by $1,373 or 1.0% primarily due to additional expenses resulting from the first quarter write-off of previously deferred regulatory expenses of $1,011, the absence of the June 2009 gain on sale of a utility system of $1,009, which had the effect of reducing operations and maintenance expense in 2009, a write-off of capitalized costs of $715, increases in operating costs associated with acquisitions of $612, increases in fuel costs for our service vehicles of $484, and normal increases in other operating costs. Offsetting these increases were decreases in water production costs of $1,167, decreased bad debt expense of $883, and reduced expenses of $158 associated with the dispositions of utility systems. The decreased water production costs, principally chemicals, was associated with vendor price decreases.

Depreciation expense increased $1,643 or 3.2% due to the utility plant placed in service since June 30, 2009, offset by the effect of the additional expense of $2,037 recognized in the first quarter of 2009 resulting from a rate case adjustment related to our rate filing in North Carolina.

Amortization increased $667 primarily due to additional amortization of $579 resulting from the recovery through a surcharge of our costs associated with our rate filing in Texas and the amortization of the costs associated with, and other costs being recovered in, various rate filings, offset by the effect of the additional amortization recognized in the first quarter of 2009 of $394 resulting from a rate case adjustment related to our rate filing in North Carolina.

AQUA AMERICA, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

(In thousands of dollars, except per share amounts)

Taxes other than income taxes increased by $2,329 or 9.9% primarily due to an increase in recoverable expenses associated with a recent rate award, an increase in capital stock taxes for our operating subsidiary in Pennsylvania, an increase in property taxes, and an increase in gross receipts, excise and franchise taxes.

Interest expense increased by $3,497 or 10.5% primarily due to an increase in borrowings to finance capital projects, offset partially by decreased interest rates on long-term debt.

Allowance for funds used during construction (“AFUDC”) increased by $1,809 primarily due to an increase in the average balance of utility plant construction work in progress, to which AFUDC is applied, and an increase in short-term interest rates, which are a component of the applied AFUDC rate.

Gain on sale of other assets totaled $2,039 during the first half of 2010 and $213 in the first half of 2009.  The increase of $1,826 is due to a gain on the sale of an investment in the first quarter of 2010.

Our effective income tax rate was 39.5% in the first half of 2010 and 39.9% in the first half of 2009. The effective income tax rate decreased due to an increase in a tax credit for qualified domestic production activities in the first six months of 2010 versus the same period in 2009.

Net income attributable to common shareholders increased by $7,142 or 16.1%, in comparison to the same period in 2009 primarily as a result of the factors described above. On a diluted per share basis, earnings increased $0.05 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, equity compensation plan, employee stock purchase plan, and the additional shares issued in August 2009 in connection with an acquisition.

Revenues increased $11,111 or 6.6% primarily due to additional revenues associated with increased water consumption as compared to the second quarter of 2009, increased water and wastewater rates of $3,129, additional revenues associated with increased infrastructure rehabilitation surcharges of $2,584, and additional water and wastewater revenues of $663 associated with a larger customer base due to acquisitions.  The increase in customer water consumption is largely due to favorable weather conditions in our service territories during the second quarter of 2010 that increased water usage.

AQUA AMERICA, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

(In thousands of dollars, except per share amounts)

Operations and maintenance expenses increased by $761 or 1.1% primarily due to the absence of the June 2009 gain on sale of a utility system of $1,009, which had the effect of reducing operations and maintenance expense in 2009, a write-off of capitalized costs of $715, increases in operating costs associated with acquisitions of $344, increases in fuel costs for our service vehicles of $235, and normal increases in other operating costs.  Offsetting these increases were decreased bad debt expense of $504, decreased water production costs of $446, and reduced expenses of $100 associated with the dispositions of utility systems.  The decreased water production costs, principally chemicals, was associated with vendor price decreases.

Depreciation expense increased $1,830 or 7.3% due to the utility plant placed in service since June 30, 2009.

Amortization increased $250 due to the amortization of the costs associated with, and other costs being recovered in, various rate filings.

Taxes other than income taxes increased by $1,059 or 8.9% primarily due to an increase in recoverable expenses associated with a recent rate award, an increase in capital stock taxes for our operating subsidiary in Pennsylvania, an increase in gross receipts, excise and franchise taxes, and an increase in property taxes.

Interest expense increased by $1,695 or 10.1% primarily due to additional borrowings to finance capital projects, offset partially by decreased interest rates on long-term debt.

Allowance for funds used during construction (“AFUDC”) increased by $893 primarily due to an increase in the average balance of utility plant construction work in progress, to which AFUDC is applied, and an increase in short-term interest rates, which are a component of the applied AFUDC rate.

Gain on sale of other assets totaled $110 in the second quarter of 2010 and $80 in the second quarter of 2009.  The increase of $30 is principally due to the timing of sales of land and other property.

Our effective income tax rate was 39.2% in the second quarter of 2010 and 39.5% in the second quarter of 2009.  The effective income tax rate decreased due to an increase in a tax credit for qualified domestic production activities in the second quarter of 2010 versus the same period in 2009.

Net income attributable to common shareholders increased by $4,002 or 15.5%, in comparison to the same period in 2009 primarily as a result of the factors described above.  On a diluted per share basis, earnings increased $0.03 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, equity compensation plan, and employee stock purchase plan, and the additional shares issued in August 2009 in connection with an acquisition.

AQUA AMERICA, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

(In thousands of dollars, except per share amounts)

We describe the impact of recent accounting pronouncements in Note 12, Recent Accounting Pronouncements, of the consolidated financial statements.

AQUA AMERICA, INC. AND SUBSIDIARIES

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, 2009.  Refer to Item 7A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for additional information.

Part II.  Other Information

In 2004, our subsidiaries in Texas filed an application with the Texas Commission on Environmental Quality (“TCEQ”) to increase rates over a multi-year period. On September 23, 2008, the TCEQ issued its final ruling with a unanimous decision approving this rate application. The final order had been appealed to the TCEQ by two parties, and the TCEQ has exercised its legal authority to take no action within the required period, therefore, affirming the TCEQ’s approval decision. Thereafter, the appealing parties filed suit against the TCEQ in the Travis County District Court in an effort to appeal the order. On April 15, 2010, the Travis County District Court Judge upheld the TCEQ’s final order, and this ruling is no longer subject to appeal.  For more information, see the description under the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2009, and refer to Note 9, Water and Wastewater Rates, to the Consolidated Financial Statements of Aqua America, Inc. and subsidiaries in this Quarterly Report on Form 10-Q for the quarter ended June 30, 2010.

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. We challenged whether the City was following the correct legal procedures in connection with the City’s condemnation, but the Indiana Supreme Court, in an opinion issued in June 2007, supported the City’s position. In October 2007, the City’s Board of Public Works approved proceeding with its process to condemn the northern portion of our utility system at a preliminary price based on the City’s valuation. In October 2007, we filed an appeal with the Allen County Circuit Court challenging the Board of Public Works’ valuation on several bases. In November 2007, the City Council au thorized the taking of this portion of our system and the payment of $16,910,500 based on the City’s valuation of the system. In January 2008, we reached a settlement agreement 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 states 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 Indiana Utility Regulatory Commission also reviewed and acknowledged the transfer of the Certificate of Territorial Authority for the northern portion of the system to the City. 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 f inal 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. Depending upon the ultimate outcome of the legal proceeding in the Allen County Circuit Court we may be required to refund a portion of the initial valuation payment, or may receive additiona l proceeds. The northern portion of the system relinquished represented approximately 0.50% of Aqua America’s total assets.

AQUA AMERICA, INC. AND SUBSIDIARIES

Two homeowners’ associations comprised of approximately 180 homes located next to a wastewater plant owned by one of the Company’s subsidiaries in Indiana claim that the subsidiary’s prior management, before our acquisition of the subsidiary in 2003, allegedly entered into an agreement to cease the majority of operations at the wastewater plant and to remove most of the facilities located at the plant site by April 2009. The plant treats approximately 75% of wastewater flow from the subsidiary’s 12,000 customers in the area. The Company filed a formal request for review of the purported agreement with the Indiana Utility Regulatory Commission (IURC). In September 2009, the homeowners’ associations filed suit in Allen County, Indiana Superior Court claiming breach of contract, breach of warranty, fr aud, unjust enrichment, promissory estoppel and constructive fraud. If the purported agreement is ultimately determined to be valid, the subsidiary may be subject to liability to the homeowners for failure to remove the plant and/or, if the agreement is enforced, the subsidiary may be required to expand another existing plant or construct a new plant elsewhere and close and remove the existing plant. The scope of any such possible expansion or construction is difficult to determine at this time, but the construction costs for new wastewater treatment plants are estimated at anywhere from $9 to $12 per gallon of flow per day. The current plant is treating an average flow of approximately 2.3 million gallons per day. The book value of the current plant is $5,000,000.  On April 26, 2010, the Company and the homeowners’ associations submitted to the IURC a settlement agreement to settle the dispute.  The settlement agreement includes the payment of $2,600,000 to the homeowners̵ 7; associations, certain conditions for future plant improvements, which should not materially interfere with the operation of the plant, and the transfer of a parcel of land to the homeowners’ associations for which the Company will receive a $50,000 credit to the settlement amount.  The settlement agreement was approved by the membership of the homeowners’ associations and is pending the approval of the IURC by final non-appealable order.  This matter would not be covered by any of the Company’s insurance policies.

AQUA AMERICA, INC. AND SUBSIDIARIES

One of the Company’s subsidiaries acquired in 2008 has been operating under a Consent Decree with the United States Environmental Protection Agency 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 number of sanitary sewer overflows at the sewer system have been made since the Company’s acquisition of the subsidiary, the Environmental Protection Agency 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.  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 intends to seek indemnification from the seller for this matter.

There are no other pending legal proceedings to which we or any of our subsidiaries is a party or to which any of their properties is the subject that we believe are material or are expected to have a material effect on our financial position, results of operations or cash flows.

There have been no material changes to the risks disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009 (“Form 10-K”) under “Part 1, Item 1A – Risk Factors.”

AQUA AMERICA, INC. AND SUBSIDIARIES

The following table summarizes Aqua America’s purchases of its common stock for the quarter ended June 30, 2010:

AQUA AMERICA, INC. AND SUBSIDIARIES

The information required by this Item is set forth in the Exhibit Index hereto which is incorporated herein by reference.

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.

EXHIBIT INDEX

In accordance with Item 601(b)(4)(iii)(A) of Regulation S-K, copies of certain instruments defining the rights of holders of long-term debt of the Company or its subsidiaries are not filed herewith.  Pursuant to this regulation, we hereby agree to furnish a copy of any such instrument to the SEC upon request.