aqua-10q_0805.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC  20549

FORM 10-Q
(Mark One)

T
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2010

£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from _________________ to _________________

Commission File Number 1-6659

AQUA AMERICA, INC.
(Exact name of registrant as specified in its charter)

Pennsylvania
  
23-1702594
(State or other jurisdiction of incorporation or organization)
  
(I.R.S. Employer Identification No.)

762 W. Lancaster Avenue,
Bryn Mawr, Pennsylvania
  
19010-3489
(Address of principal executive offices)
  
(Zip Code)

(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   T    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   T    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.:

Large accelerated filer
x
  
Accelerated filer
¨
         
Non-accelerated filer
¨
  
Smaller reporting company
¨
(do not check if a smaller reporting company)
      

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes   £    No   T

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of July 23, 2010:  137,258,091

 
 
 

TABLE OF CONTENTS
 
AQUA AMERICA, INC. AND SUBSIDIARIES

   
Page
     
 
Part I – Financial Information
  
     
Item 1.
Financial Statements:
  
     
 
Consolidated Balance Sheets (unaudited) – June 30, 2010 and December 31, 2009
2
     
 
Consolidated Statements of Income and Comprehensive Income (unaudited) –
Six Months Ended June 30, 2010 and 2009
3
     
 
Consolidated Statements of Income and Comprehensive Income (unaudited) –
Three Months Ended June 30, 2010 and 2009
4
     
 
Consolidated Statements of Capitalization (unaudited) –
June 30, 2010 and December 31, 2009
5
     
 
Consolidated Statement of Equity (unaudited) –
Six Months Ended June 30, 2010
6
     
 
Consolidated Statements of Cash Flow (unaudited) –
Six Months Ended June 30, 2010 and 2009
7
     
 
Notes to Consolidated Financial Statements (unaudited)
8
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
18
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
24
     
Item 4.
Controls and Procedures
24
     
 
Part II – Other Information
  
     
Item 1.
Legal Proceedings
24
     
Item 1A.
Risk Factors
27
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
28
     
Item 6.
Exhibits
29
     
Signatures
  
30
     
Exhibit Index   
  
31

1 
 
 

Part 1 – Financial Information
Item 1.
Financial Statements

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(In thousands of dollars, except per share amounts)
(UNAUDITED)

   
June 30,
    
December 31,
  
Assets
  
2010
    
2009
  
Property, plant and equipment, at cost
   $ 4,308,360     $ 4,141,690  
Less: accumulated depreciation
     967,167       914,396  
Net property, plant and equipment
     3,341,193       3,227,294  
Current assets:
                
Cash and cash equivalents
     13,112       21,869  
Accounts receivable and unbilled revenues, net
     85,597       78,742  
Inventory, materials and supplies
     9,916       9,519  
Prepayments and other current assets
     10,538       11,441  
Total current assets
     119,163       121,571  
                 
Regulatory assets
     221,440       226,351  
Deferred charges and other assets, net
     60,748       59,468  
Funds restricted for construction activity
     81,634       84,830  
Goodwill
     43,201       43,083  
    $ 3,867,379     $ 3,762,597  
Liabilities and Equity
                
Aqua America stockholders' equity:
                
Common stock at $.50 par value, authorized 300,000,000 shares, issued 137,846,662 and 137,148,749 in 2010 and 2009
   $ 68,923     $ 68,574  
Capital in excess of par value
     651,985       642,786  
Retained earnings
     421,090       409,402  
Treasury stock, at cost, 674,570 and 662,410 shares in 2010 and 2009
     (12,327 )     (12,138 )
Accumulated other comprehensive income (loss)
     (148 )     280  
Total Aqua America stockholders' equity
     1,129,523       1,108,904  
                 
Noncontrolling interest
     559       560  
                 
Total equity
     1,130,082       1,109,464  
                 
Long-term debt, excluding current portion
     1,461,606       1,386,557  
Commitments and contingencies
     -       -  
                 
Current liabilities:
                
Current portion of long-term debt
     35,226       59,577  
Loans payable
     51,433       27,487  
Accounts payable
     49,700       57,862  
Accrued interest
     17,740       16,265  
Accrued taxes
     18,481       18,813  
Other accrued liabilities
     26,001       21,003  
Total current liabilities
     198,581       201,007  
                 
Deferred credits and other liabilities:
                
Deferred income taxes and investment tax credits
     414,357       408,583  
Customers' advances for construction
     68,995       76,913  
Regulatory liabilities
     30,829       28,812  
Other
     111,668       114,490  
Total deferred credits and other liabilities
     625,849       628,798  
                 
Contributions in aid of construction
     451,261       436,771  
    $ 3,867,379     $ 3,762,597  
                 
See notes to consolidated financial statements beginning on page 8 of this report.
          

 
2
 

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(In thousands, except per share amounts)
(UNAUDITED)

   
Six Months Ended
  
   
June 30,
  
   
2010
    
2009
  
             
Operating revenues
   $ 338,961     $ 321,820  
                 
Operating expenses:
                
Operations and maintenance
     136,911       135,538  
Depreciation
     53,002       51,359  
Amortization
     6,486       5,819  
Taxes other than income taxes
     25,803       23,474  
      222,202       216,190  
                 
Operating income
     116,759       105,630  
                 
Other expense (income):
                
Interest expense, net
     36,934       33,437  
Allowance for funds used during construction
     (3,002 )     (1,193 )
Gain on sale of other assets
     (2,039 )     (213 )
Income before income taxes
     84,866       73,599  
Provision for income taxes
     33,500       29,375  
Net income attributable to common shareholders
   $ 51,366     $ 44,224  
                 
Net income attributable to common shareholders
   $ 51,366     $ 44,224  
Other comprehensive income, net of tax:
                
Unrealized holding gain on investments
     902       269  
Reclassification adjustment for (gains) losses reported in net income
     (1,330 )     5  
Comprehensive income
   $ 50,938     $ 44,498  
                 
Net income per common share:
                
Basic
   $ 0.38     $ 0.33  
Diluted
   $ 0.38     $ 0.33  
                 
Average common shares outstanding during the period:
                
Basic
     136,647       135,519  
Diluted
     136,960       135,880  
                 
Cash dividends declared per common share
   $ 0.290     $ 0.270  
                 
See notes to consolidated financial statements beginning on page 8 of this report.
  

 
3
 

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(In thousands, except per share amounts)
(UNAUDITED)

   
Three Months Ended
  
   
June 30,
  
   
2010
    
2009
  
             
Operating revenues
   $ 178,444     $ 167,333  
                 
Operating expenses:
                
Operations and maintenance
     69,310       68,549  
Depreciation
     26,802       24,972  
Amortization
     3,314       3,064  
Taxes other than income taxes
     12,943       11,884  
      112,369       108,469  
                 
Operating income
     66,075       58,864  
                 
Other expense (income):
                
Interest expense, net
     18,504       16,809  
Allowance for funds used during construction
     (1,461 )     (568 )
Gain on sale of other assets
     (110 )     (80 )
Income before income taxes
     49,142       42,703  
Provision for income taxes
     19,287       16,850  
Net income attributable to common shareholders
   $ 29,855     $ 25,853  
                 
Net income attributable to common shareholders
   $ 29,855     $ 25,853  
Other comprehensive income, net of tax:
                
Unrealized holding gain on investments
     0       232  
Reclassification adjustment for losses reported in net income
     0       5  
Comprehensive income
   $ 29,855     $ 26,090  
                 
Net income per common share:
                
Basic
   $ 0.22     $ 0.19  
Diluted
   $ 0.22     $ 0.19  
                 
Average common shares outstanding during the period:
                
Basic
     136,785       135,631  
Diluted
     137,012       135,939  
                 
Cash dividends declared per common share
   $ 0.145     $ 0.135  
                 
See notes to consolidated financial statements beginning on page 8 of this report.
  

 
4
 

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CAPITALIZATION
(In thousands of dollars, except per share amounts)
(UNAUDITED)

   
June 30,
    
December 31,
  
   
2010
    
2009
  
Aqua America stockholders' equity:
            
Common stock, $.50 par value
   $ 68,923     $ 68,574  
Capital in excess of par value
     651,985       642,786  
Retained earnings
     421,090       409,402  
Treasury stock, at cost
     (12,327 )     (12,138 )
Accumulated other comprehensive income
     (148 )     280  
Total Aqua America stockholders' equity
     1,129,523       1,108,904  
                 
Noncontrolling interest
     559       560  
                 
Total equity
     1,130,082       1,109,464  
                 
Long-term debt:
                
Long-term debt of subsidiaries (substantially secured by utility plant):
                
                 
Interest Rate Range
Maturity Date Range
            
0.00% to 0.99%
2012 to 2034
     6,587       6,868  
1.00% to 1.99%
2011 to 2035
     21,559       21,917  
2.00% to 2.99%
2019 to 2029
     14,195       12,935  
3.00% to 3.99%
2010 to 2025
     27,014       28,455  
4.00% to 4.99%
2020 to 2041
     270,634       271,346  
5.00% to 5.99%
2011 to 2043
     384,533       384,694  
6.00% to 6.99%
2011 to 2036
     121,582       121,876  
7.00% to 7.99%
2012 to 2025
     30,704       31,236  
8.00% to 8.99%
2021 to 2025
     34,404       34,543  
9.00% to 9.99%
2011 to 2026
     49,488       69,983  
10.40%
2018
     6,000       6,000  
        966,700       989,853  
                   
Notes payable to bank under revolving credit agreement, variable rate, due May 2012
     68,000       64,149  
Unsecured notes payable:
                
Notes ranging from 4.62% to 4.87%, due 2010 through 2024
     220,000       185,000  
Notes ranging from 5.01% to 5.95%, due 2014 through 2037
     242,132       207,132  
      1,496,832       1,446,134  
Current portion of long-term debt
     35,226       59,577  
Long-term debt, excluding current portion
     1,461,606       1,386,557  
Total capitalization
   $ 2,591,688     $ 2,496,021  
                 
See notes to consolidated financial statements beginning on page 8 of this report.
  


 
5
 

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EQUITY
(In thousands of dollars)
(UNAUDITED)

                           
Accumulated
              
         
Capital in
                
Other
              
   
Common
    
Excess of
    
Retained
    
Treasury
    
Comprehensive
    
Noncontrolling
        
   
Stock
    
Par Value
    
Earnings
    
Stock
    
Income (Loss)
    
Interest
    
Total
  
Balance at December 31, 2009
   $ 68,574     $ 642,786     $ 409,402     $ (12,138 )   $ 280     $ 560     $ 1,109,464  
Net income
     0       0       51,366       0       0       (1 )     51,365  
Unrealized holding gain on investments, net of income tax of $486
     0       0       0       0       902       0       902  
Reclassification adjustment for gain reported in net income, net of income tax of $716
     0       0       0       0       (1,330 )     0       (1,330 )
Dividends paid
     0       0       (39,678 )     0       0       0       (39,678 )
Sale of stock (377,668 shares)
     180       5,670       0       338       0       0       6,188  
Repurchase of stock (30,033 shares)
     0       0       0       (527 )     0       0       (527 )
Equity compensation plan (190,838 shares)
     95       (95 )     0       0       0       0       0  
Exercise of stock options (147,280 shares)
     74       1,337       0       0       0       0       1,411  
Stock-based compensation
     0       2,157       0       0       0       0       2,157  
Employee stock plan tax benefits
     0       130       0       0       0       0       130  
Balance at June 30, 2010
   $ 68,923     $ 651,985     $ 421,090     $ (12,327 )   $ (148 )   $ 559     $ 1,130,082  
                                                         
See notes to consolidated financial statements beginning on page 8 of this report.
  


 
6
 

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOW
(In thousands of dollars)
(UNAUDITED)

   
Six Months Ended
  
   
June 30,
  
   
2010
    
2009
  
Cash flows from operating activities:
            
Net income attributable to common shareholders
   $ 51,366     $ 44,224  
Adjustments to reconcile net income attributable to common shareholders to net cash flows from operating activities:
                
Depreciation and amortization
     59,488       57,178  
Deferred income taxes
     4,495       18,218  
Provision for doubtful accounts
     2,233       3,116  
Stock-based compensation
     2,159       1,830  
Gain on sale of utility system
     0       (1,009 )
Gain on sale of other assets
     (2,039 )     (213 )
Net increase in receivables, inventory and prepayments
     (8,019 )     (3,758 )
Net decrease in payables, accrued interest, accrued taxes and other accrued liabilities
     (6,684 )     (12,116 )
Other
     (3,233 )     (921 )
Net cash flows from operating activities
     99,766       106,549  
Cash flows from investing activities:
                
Property, plant and equipment additions, including allowance for funds used during construction of $3,002 and $1,193
     (140,767 )     (117,134 )
Acquisitions of utility systems and other, net
     (1,621 )     (1,170 )
Additions to funds restricted for construction activity
     (1,020 )     (4,901 )
Release of funds previously restricted for construction activity
     4,216       33,299  
Net proceeds from the sale of utility system and other assets
     3,297       1,937  
Other
     (4,633 )     (768 )
Net cash flows used in investing activities
     (140,528 )     (88,737 )
Cash flows from financing activities:
                
Customers' advances and contributions in aid of construction
     4,243       2,524  
Repayments of customers' advances
     (4,818 )     (1,306 )
Net proceeds of short-term debt
     23,946       16,489  
Proceeds from long-term debt
     101,329       3,705  
Repayments of long-term debt
     (50,897 )     (3,650 )
Change in cash overdraft position
     (9,309 )     (7,328 )
Proceeds from issuing common stock
     6,188       5,896  
Proceeds from exercised stock options
     1,411       1,540  
Stock-based compensation windfall tax benefits
     117       92  
Repurchase of common stock
     (527 )     (300 )
Dividends paid on common stock
     (39,678 )     (36,596 )
Net cash flows from (used) in financing activities
     32,005       (18,934 )
                 
Net decrease in cash and cash equivalents
     (8,757 )     (1,122 )
Cash and cash equivalents at beginning of period
     21,869       14,944  
Cash and cash equivalents at end of period
   $ 13,112     $ 13,822  
                 
See notes to consolidated financial statements beginning on page 8 of this report.
  

 
7
 

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of dollars, except per share amounts)
(UNAUDITED)


Note 1
Basis of Presentation
   
 
The accompanying consolidated balance sheets and statements of capitalization of Aqua America, Inc. and subsidiaries (the “Company”) at June 30, 2010, the consolidated statements of income and comprehensive income for the six and three months ended June 30, 2010 and 2009, the consolidated statements of cash flow for the six months ended June 30, 2010 and 2009, and the consolidated statement of equity for the six months ended June 30, 2010, 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, 2009.  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, 2009 consolidated balance sheet data presented herein was derived from the Company’s December 31, 2009 audited consolidated financial statements, but does not include all disclosures and notes normally provided in annual financial statements.
   
Note 2
Goodwill
   
 
The following table summarizes the changes in the Company’s goodwill, by business segment:

   
Regulated
Segment
    
Other
    
Consolidated
  
                   
Balance at December 31, 2009
   $ 38,962     $ 4,121     $ 43,083  
Goodwill acquired during year
     28       0       28  
Other
     90       0       90  
Balance at June 30, 2010
   $ 39,080     $ 4,121     $ 43,201  

Note 3
Dispositions
   
 
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 operating subsidiaries that the Company acquired in connection with the AquaSource acquisition in 2003. The Company challenged whether the City was following the correct legal procedures in connection with the City’s attempted 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 the Company’s utility system at a preliminary price based on the City’s valuation. The Company has 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 authorized the taking of the northern portion of the Company’s system and the payment of $16,911 based on the City’s valuation of this portion of the system. 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 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 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 on certain procedural aspects with respect to the valuation evidence that may be presented and whether the Company is entitled to a jury trial. Depending upon the outcome of the legal proceeding, 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 0.50% of the Company’s total assets.

 
8
 

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)

Note 4
Long-term Debt and Loans Payable
   
 
In June 2010, the Company issued $70,000 of senior unsecured notes, of which $15,000 is due in 2021, $20,000 in 2024, and $35,000 in 2028 with interest rates of 4.62%, 4.83%, and 5.22%.
   
Note 5
Fair Value of Financial Instruments
   
 
The carrying amount of current assets and liabilities that are considered financial instruments approximates their fair value as of the dates presented.  The carrying amount and estimated fair value of the Company’s long-term debt are as follows:

   
June 30,
    
December 31,
  
   
2010
    
2009
  
Carrying Amount
   $ 1,496,832     $ 1,446,134  
Estimated Fair Value
     1,500,690       1,315,954  

 
9
 

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)

 
The fair value of long-term debt has been determined by discounting the future cash flows using current market interest rates for similar financial instruments of the same duration.  The Company’s customers’ advances for construction and related tax deposits have a carrying value of $68,529 as of June 30, 2010, and $76,913 as of December 31, 2009. 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 2025 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.
   
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 options is included in the computation of diluted net income per common share.  The dilutive effect of stock options is calculated using the treasury stock method and expected proceeds upon exercise of the stock options.  The following table summarizes the shares, in thousands, used in computing basic and diluted net income per common share:

   
Six Months Ended
    
Three Months Ended
  
   
June 30,
    
June 30,
  
   
2010
    
2009
    
2010
    
2009
  
Average common shares outstanding during the period for basic computation
     136,647       135,519       136,785       135,631  
Dilutive effect of employee stock options
     313       361       227       308  
Average common shares outstanding during the period for diluted computation
     136,960       135,880       137,012       135,939  

 
For the six and three months ended June 30, 2010, employee stock options to purchase 2,665,445 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 six and three months ended June 30, 2009, employee stock options to purchase 2,144,059 and 2,720,294 shares of common stock, respectively, 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
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 June 30, 2010, 4,328,625 shares underlying stock option and restricted stock awards were still available for grants under the 2009 Plan.  No further grants may be made under the 2004 Plan.
   


 
10
 

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)

 
Stock Options– During the six months ended June 30, 2010 and 2009, the Company recognized compensation costs associated with stock options as a component of operations and maintenance expense of $1,013 and $1,201, respectively.  During the three months ended June 30, 2010 and 2009, the Company recognized compensation costs associated with stock options as a component of operations and maintenance expense of $519 and $658, respectively.  For the six months ended June 30, 2010 and 2009, the Company recognized income tax benefits associated with stock options in its income statement of $301 and $235, respectively.  For the three months ended June 30, 2010 and 2009, the Company recognized income tax benefits associated with stock options in its income statement of $149 and $134, respectively.  In addition, the Company capitalized compensation costs associated with stock options within property, plant and equipment of $0 and $73 during the six and three months ended June 30, 2010 and 2009, respectively.
   
 
The fair value of options was estimated at the grant date using the Black-Scholes option-pricing model.  The per share weighted-average fair value at the date of grant for stock options granted during the six months ended June 30, 2010 and 2009 was $3.49 and $4.37 per option, respectively.  There were no stock options granted during the three months ended June 30, 2010 and 2009.  The following assumptions were used in the application of this valuation model:

   
2010
    
2009
  
Expected term (years)
     6.0       5.3  
Risk-free interest rate
     2.8 %     2.2 %
Expected volatility
     26.7 %     31.3 %
Dividend yield
     3.3 %     3.0 %

 
Historical information was the principal basis for the selection of the expected term and dividend yield.  The expected volatility is based on a weighted-average combination of historical and implied volatilities over a time period that approximates the expected term of the option.  The risk-free interest rate was selected based upon the U.S. Treasury yield curve in effect at the time of grant for the expected term of the option.


 
11
 

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)

 
The following table summarizes stock option transactions for the six months ended June 30, 2010:

         
Weighted
    
Weighted
        
         
Average
    
Average
    
Aggregate
  
         
Exercise
    
Remaining
    
Intrinsic
  
   
Shares
    
Price
    
Life (years)
    
Value
  
Options:
                        
Outstanding at beginning of period
     3,895,329     $ 19.17              
Granted
     459,837       17.14              
Forfeited
     (10,835 )     18.83              
Expired
     (22,357 )     21.93              
Exercised
     (147,280 )     9.58              
Outstanding at end of period
     4,174,694     $ 19.27       6.0     $ 4,241  
                                 
Exercisable at end of period
     3,152,340     $ 19.55       5.1     $ 3,996  

 
Restricted Stock– During the six months ended June 30, 2010 and 2009, the Company recorded stock-based compensation related to restricted stock awards as a component of operations and maintenance expense in the amounts of $1,144 and $629, respectively.  During the three months ended June 30, 2010 and 2009, the Company recorded stock-based compensation related to restricted stock awards as a component of operations and maintenance expense in the amounts of $692 and $443, respectively.  The following table summarizes nonvested restricted stock transactions for the six months ended June 30, 2010:

   
Number
    
Weighted
  
   
of
    
Average
  
   
Shares
    
Fair Value
  
             
Nonvested shares at beginning of period
     102,918     $ 19.73  
Granted
     191,288       17.10  
Vested
     (53,837 )     20.23  
Forfeited
     (450 )     17.23  
Nonvested shares at end of period
     239,919     $ 17.53  


 
12
 

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)

Note 8
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:

   
Pension Benefits
  
   
Six Months Ended
    
Three Months Ended
  
   
June 30,
    
June 30,
  
   
2010
    
2009
    
2010
    
2009
  
Service cost
   $ 2,344     $ 2,174     $ 1,172     $ 1,050  
Interest cost
     6,440       6,263       3,220       3,150  
Expected return on plan assets
     (5,592 )     (4,658 )     (2,796 )     (2,341 )
Amortization of transition asset
     0       (91 )     0       (45 )
Amortization of prior service cost
     70       76       35       41  
Amortization of actuarial loss
     2,060       2,576       1,030       1,374  
Capitalized costs
     (1,685 )     (1,320 )     (888 )     (649 )
Settlement charge
     884       641       884       641  
Net periodic benefit cost
   $ 4,521     $ 5,661     $ 2,657     $ 3,221  
                                 
   
Other
  
   
Postretirement Benefits
  
   
Six Months Ended
    
Three Months Ended
  
   
June 30,
    
June 30,
  
      2010       2009       2010       2009  
Service cost
   $ 610     $ 541     $ 305     $ 262  
Interest cost
     1,240       1,144       620       571  
Expected return on plan assets
     (924 )     (845 )     (462 )     (423 )
Amortization of transition obligation
     52       52       26       26  
Amortization of prior service cost
     (134 )     (140 )     (67 )     (70 )
Amortization of actuarial loss
     342       294       171       159  
Amortization of regulatory asset
     68       68       34       30  
Capitalized costs
     (250 )     (180 )     (129 )     (88 )
Net periodic benefit cost
   $ 1,004     $ 934     $ 498     $ 467  

 
The Company made cash contributions of $8,863 to its defined benefit pension plans during the first six months of 2010, and intends to make cash contributions of $4,143 to the plans during the remainder of 2010.  In addition, the Company made cash contributions of $191 and expects to make cash contributions of $1,494 for the funding of its other postretirement benefit plans during the remainder of 2010.

 
13
 

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)

Note 9
Water and Wastewater Rates
   
 
On June 17, 2010, the Pennsylvania Public Utility Commission granted the Company’s operating subsidiary in Pennsylvania a water rate increase designed to increase total operating revenues by $23,600, on an annualized basis.  The rates in effect at the time of the filing included $24,256 in Distribution System Improvement Charges (“DSIC”) or 7.5% above prior base rates.  Consequently, the total base rates increased by $47,856, and the DSIC was reset to zero.
   
 
During the first six months of 2010, the Company’s operating divisions in New York, New Jersey, North Carolina, Ohio, Missouri, and Indiana were granted base rate increases designed to increase total operating revenues on an annual basis by approximately $10,985.
   
 
On September 23, 2008, the Texas Commission on Environmental Quality (“TCEQ”) issued its final ruling with a unanimous decision approving the rate application that was filed in 2004 by the Company’s operating subsidiaries in Texas to increase rates, on an annualized basis, by $11,920 over a multi-year period beginning in 2004.  The application sought to increase annual revenues in phases and was accompanied by a plan to defer and amortize a portion of the Company’s depreciation, operating and other tax expense over a similar multi-year period, such that the impact on operating income approximated the requested amount during the first years that the new rates were in effect.  The Company commenced billing for the requested rates and implemented the deferral plan in 2004.  As a result of the final order, the regulatory asset for the deferred operating costs and rate case expenses was set at $13,697.  As of February 1, 2009, recovery of the regulatory assets for the deferred operating costs and rate case expenses began through two surcharge mechanisms. The final order was appealed to the TCEQ by two parties, and the TCEQ 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 an effort to appeal the order.  On April 15, 2010, a hearing on the appeal of TCEQ’s approval decision was held in the Travis County Texas District Court, which resulted in the TCEQ’s final order being upheld by the District Court Judge.  The Travis County District Court Judge’s ruling is no longer subject to appeal.

 
14
 

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)

Note 10
Taxes Other than Income Taxes
   
 
The following table provides the components of taxes other than income taxes:

   
Six Months Ended
    
Three Months Ended
  
   
June 30,
    
June 30,
  
   
2010
    
2009
    
2010
    
2009
  
                         
Property
   $ 13,039     $ 12,518     $ 6,513     $ 6,355  
Capital stock
     1,791       1,246       924       641  
Gross receipts, excise and franchise
     4,680       4,206       2,459       2,254  
Payroll
     3,748       3,731       1,600       1,652  
Other
     2,545       1,773       1,447       982  
Total taxes other than income
   $ 25,803     $ 23,474     $ 12,943     $ 11,884  


 
15
 

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)

Note 11
Segment Information
   
 
The Company has identified fifteen operating segments and has one reportable segment named the “Regulated” segment.  The reportable segment is comprised of fourteen 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, one segment is not quantitatively significant to be reportable and is comprised of the businesses that provide on-site septic tank pumping, sludge hauling services and certain other non-regulated water and wastewater services.  This segment is 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.
   
 
The following tables present the Company’s segment information:

   
Three Months Ended
    
Three Months Ended
  
   
June 30, 2010
    
June 30, 2009
  
   
Regulated
    
Other
    
Consolidated
    
Regulated
    
Other
    
Consolidated
  
Operating revenues
   $ 175,593     $ 2,851     $ 178,444     $ 164,308     $ 3,025     $ 167,333  
Operations and maintenance expense
     66,523       2,787       69,310       65,643       2,906       68,549  
Depreciation
     27,179       (377 )     26,802       25,355       (383 )     24,972  
Operating income
     66,038       37       66,075       58,755       109       58,864  
Interest expense, net of AFUDC
     16,342       701       17,043       16,155       86       16,241  
Income tax
     20,009       (722 )     19,287       17,061       (211 )     16,850  
Net income attributable to common shareholders
     29,797       58       29,855       25,626       227       25,853  
                                                 
   
Six Months Ended
    
Six Months Ended
  
   
June 30, 2010
    
June 30, 2009
  
   
Regulated
    
Other
    
Consolidated
    
Regulated
    
Other
    
Consolidated
  
Operating revenues
   $ 333,599     $ 5,362     $ 338,961     $ 316,039     $ 5,781     $ 321,820  
Operations and maintenance expense
     132,581       4,330       136,911       131,270       4,268       135,538  
Depreciation
     53,784       (782 )     53,002       52,136       (777 )     51,359  
Operating income
     115,889       870       116,759       104,188       1,442       105,630  
Interest expense, net of AFUDC
     32,565       1,367       33,932       32,052       192       32,244  
Gain (Loss) on sale of other assets
     (7 )     2,046       2,039       201       12       213  
Income tax
     33,853       (353 )     33,500       29,328       47       29,375  
Net income attributable to common shareholders
     49,464       1,902       51,366       43,009       1,215       44,224  
Capital expenditures
     140,500       267       140,767       116,364       770       117,134  

 
16
 

AQUA AMERICA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands of dollars, except per share amounts)
(UNAUDITED)

   
June 30,
    
December 31,
  
   
2010
    
2009
  
Total assets:
            
Regulated
   $ 3,794,835     $ 3,689,689  
Other and eliminations
     72,544       72,908  
Consolidated
   $ 3,867,379     $ 3,762,597  

Note 12
Recent Accounting Pronouncements
   
 
In June 2009, the Financial Accounting Standards Board issued revised accounting guidance for variable interest entities, which replaces the quantitative approach for determining which reporting entity has a controlling financial interest in a variable interest entity with a qualitative approach that focuses on which reporting entity controls the most significant economic activities of the variable interest entity.  The revised guidance is effective January 1, 2010.  The Company adopted the revised guidance as required, and the adoption did not have an impact on the Company’s consolidated results of operations or consolidated financial position.
   
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 June 30, 2010, the aggregate amount of $12,863 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.  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, Aqua America has insurance coverage for certain of these loss contingencies, and as of June 30, 2010, estimates that approximately $1,619 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.


 
17
 

AQUA AMERICA, INC. AND SUBSIDIARIES
 
Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(In thousands of dollars, except per share amounts)

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, 2009 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, 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.

 
18
 

AQUA AMERICA, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
 (In thousands of dollars, except per share amounts)

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 extended our regulated operations from southeastern Pennsylvania to include operations in 13 other states.

Financial Condition

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 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.

 
19
 

AQUA AMERICA, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
 (In thousands of dollars, except per share amounts)

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.

Results of Operations

Analysis of First Six Months of 2010 Compared to First Six Months of 2009

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.


 
20
 

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.

Results of Operations

Analysis of Second Quarter of 2010 Compared to Second Quarter of 2009

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.

 
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AQUA AMERICA, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
(In thousands of dollars, except per share amounts)

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.

 
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AQUA AMERICA, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
(In thousands of dollars, except per share amounts)

Impact of Recent Accounting Pronouncements

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

 
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AQUA AMERICA, INC. AND SUBSIDIARIES

Item 3.
Quantitative and Qualitative Disclosures About Market Risk

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.

Item 4.
Controls and Procedures

 
(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.

Part II.  Other Information

Item 1.
Legal Proceedings

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.

 
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AQUA AMERICA, INC. AND SUBSIDIARIES
 
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 authorized 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 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. 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 additional proceeds. The northern portion of the system relinquished represented approximately 0.50% of Aqua America’s total assets.

 
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AQUA AMERICA, INC. AND SUBSIDIARIES

A lawsuit was filed by a husband and wife who lived in a house abutting a percolation pond at a wastewater treatment plant owned by one of the Company’s subsidiaries, Aqua Utilities Florida, Inc., in Pasco County, Florida. The lawsuit was originally filed in August 2006 in the circuit court for the Sixth Judicial Circuit in and for Pasco County, Florida and has been amended several times by the plaintiffs. The lawsuit alleges our subsidiary was negligent in the design, operation and maintenance of the plant, resulting in bodily injury to the plaintiffs and various damages to their property. The plaintiffs filed an amended complaint in July 2008 to include additional counts alleging nuisance and strict liability. In the third quarter of 2008, approximately thirty-five additional plaintiffs, associated with approximately eight other homes in the area, filed another lawsuit with the same court making similar allegations against our subsidiary with respect to the operation of the facility. Both lawsuits have been submitted to our insurance carriers, who have reserved their rights with respect to various portions of the plaintiffs’ claims. Based on the ultimate outcome of the litigation, we may or may not have insurance coverage for parts or all of the claims. The Company continues to assess the matter and any potential losses. At this time, the Company believes that the estimated amount of any potential losses would not be material to the Company’s consolidated results of operations or consolidated financial condition.

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, fraud, 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 homeowners’ 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.

 
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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.

Item 1A.
Risk Factors

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.”

 
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AQUA AMERICA, INC. AND SUBSIDIARIES

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

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

Issuer Purchases of Equity Securities

             
                         
               
Total
    
Maximum
  
               
Number of
    
Number of
  
               
Shares
    
Shares
  
               
Purchased
    
that May
  
               
as Part of
    
Yet be
  
   
Total
          
Publicly
    
Purchased
  
   
Number
    
Average
    
Announced
    
Under the
  
   
of Shares
    
Price Paid
    
Plans or
    
Plan or
  
Period
  
Purchased (1)
    
per Share
    
Programs
    
Programs (2)
  
                         
April 1 - 30, 2010
     10,180     $ 18.02       0       548,278  
May 1 - 31, 2010
     0     $ 0       0       548,278  
June 1 - 30, 2010
     0     $ 0       0       548,278  
Total
     10,180     $ 18.02       0       548,278  

 
(1)
These amounts consist of shares we purchased from employees who elected to pay the exercise price of their stock options (and then hold shares of the stock) upon exercise by delivering to us (and, thus, selling) shares of Aqua America common stock in accordance with the terms of our equity compensation plans that were previously approved by our shareholders and disclosed in our proxy statements. This feature of our equity compensation plan is available to all employees who receive stock-based compensation under the plans.  We purchased these shares at their fair market value, as determined by reference to the closing price of our common stock on the day of vesting of the restricted stock award or on the day prior to the option exercise.

 
(2)
On August 5, 1997, our Board of Directors authorized a common stock repurchase program that was publicly announced on August 7, 1997, for up to 1,007,351 shares.  No repurchases have been made under this program since 2000.  The program has no fixed expiration date.  The number of shares authorized for purchase was adjusted as a result of the stock splits effected in the form of stock distributions since the authorization date.

 
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AQUA AMERICA, INC. AND SUBSIDIARIES

Item 6.
Exhibits

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


 
29
 


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.


August 6, 2010
    
     
Aqua America, Inc.
     
Registrant


     
Nicholas DeBenedictis
     
Nicholas DeBenedictis
Chairman, President and
Chief Executive Officer


     
David P. Smeltzer
     
David P. Smeltzer
     
Chief Financial Officer



 
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EXHIBIT INDEX




 
Exhibit No.   
 
Description
 
 
 
 
 
 
 
 
 
 
101.INS
XBRL Instance Document
 
101.SCH
XBRL Taxonomy Extension Schema Document
 
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
 
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
 
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
 
101.PRES
XBRL Taxonomy Extension Presentation Linkbase Document
 

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.


31