UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON DC  20549

FORM 10-Q

(Mark One) 

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934. 

For the quarterly period ended September 30, 2018 

☐ 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) 





(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 ☒  No ☐



Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).  Yes ☒  No ☐



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12(b)-2 of the Exchange Act.:   



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐



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

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of  

October 24, 2018: 177,939,879

  

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TABLE OF CONTENTS







 

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Note 1 – Basis of Presentation 



The accompanying consolidated balance sheets and statements of capitalization of Aqua America, Inc. and subsidiaries (the “Company”) at September 30, 2018, the consolidated statements of net income and comprehensive income for the three and nine months ended September 30, 2018 and 2017 the consolidated statements of cash flow for the nine months ended September 30, 2018 and 2017, and the consolidated statement of equity for the nine months ended September 30, 2018 are unaudited, but reflect all adjustments, consisting of only normal recurring accruals, which are, in the opinion of management, necessary to present a fair statement of its consolidated financial position, consolidated changes in equity, consolidated results of operations, and 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, 2017.  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, 2017 consolidated balance sheet data presented herein was derived from the Company’s December 31, 2017 audited consolidated financial statements, but does not include all disclosures and notes normally provided in annual financial statements.  Certain prior period amounts have been reclassified to conform to the current period presentation in the consolidated statements of net income as a result of the adoption, in the first quarter of 2018, of the Financial Accounting Standards Board’s (“FASB”) accounting guidance on the presentation of net periodic pension and postretirement benefit cost (refer to Note 16 – Recent Accounting Pronouncements).



The preparation of financial statements often requires the selection of specific accounting methods and policies.  Further, significant estimates and judgments may be required in selecting and applying those methods and policies in the recognition of the assets and liabilities in its consolidated balance sheets, the revenues and expenses in its consolidated statements of net income, and the information that is contained in its summary of significant accounting policies and notes to consolidated financial statements.  Making these estimates and judgments requires the analysis of information concerning events that may not yet be complete and of facts and circumstances that may change over time.  Accordingly, actual amounts or future results can differ materially from those estimates that the Company includes currently in its consolidated financial statements, summary of significant accounting policies, and notes.



There have been no changes to the summary of significant accounting policies, other than as described in Note 2 – Revenue Recognition as a result of the adoption of a new accounting pronouncement adopted on January 1, 2018, previously identified in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

 

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Note 2 – Revenue Recognition



The Company recognizes revenue as water and wastewater services are provided to our customers, which happens over time as the service is delivered and the performance obligation is satisfied.  The Company’s utility revenues recognized in an accounting period include amounts billed to customers on a cycle basis and unbilled amounts based on estimated usage from the last billing to the end of the accounting period.  Unbilled amounts are calculated by deriving estimates based on average usage of the prior month.  The Company’s actual results could differ from these estimates, which would result in operating revenues being adjusted in the period that the revision to our estimates is determined.  Unbilled amounts are included in accounts receivable and unbilled revenues, net on the consolidated balance sheet.   



Generally, payment is due within 30 days once a bill is issued to a customer.  Sales tax and other taxes we collect on behalf of government authorities, concurrent with our revenue-producing activities, are primarily excluded from revenue.  The Company has determined that its revenue recognition is not materially different under the FASB’s new accounting standard for revenue from contracts with customer, and has not made any changes to our accounting policy.  The Company’s revenues are being reported identical in the consolidated statements of net income to how they were reported under the FASB’s former accounting standard for revenue recognition.  The following table presents our revenues disaggregated by major source and customer class:







Revenues from Contracts with Customers – These revenues are composed of three main categories:  water, wastewater, and other.  Water revenues represent revenues earned for supplying customers with water service.  Wastewater revenues represent revenues earned for treating wastewater and releasing it into the water supply.  Other revenues are associated fees that relate to the regulated business but are not water and wastewater revenues.  See description below for a discussion on the performance obligation for each of these revenue streams.



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Tariff Revenues – These revenues are categorized by customer class:  residential, commercial, fire protection, industrial, and other water and other wastewater.  The rates that generate these revenues are approved by the respective state utility commission, and revenues are billed cyclically and accrued for when unbilled.  Other water and other wastewater revenues consist primarily of fines, penalties, surcharges, and availability lot fees.  Our performance obligation for tariff revenues is to provide potable water or wastewater treatment service to customers.  This performance obligation is satisfied over time as the services are rendered.  The amounts that the Company has a right to invoice for tariff revenues reflect the right to consideration from the customers in an amount that corresponds directly with the value transferred to the customer for the performance completed to date.  The Company elected to use the right to invoice practical expedient for these revenues as the Company recognizes revenue in the amount for which the Company has the right to invoice the customer.    



Other Utility Revenues – Other utility revenues represent revenues earned primarily from:  antenna revenues, which represent fees received from telecommunication operators that have put cellular antennas on our water towers, operation and maintenance and billing contracts, which represent fees earned from municipalities for our operation of their water or wastewater treatment services or performing billing services, and fees earned from developers for accessing our water mains.  The performance obligations vary for these revenues, but all are primarily recognized over time as the service is delivered.



Alternative Revenue Program – These revenues represent the difference between the actual billed utility water and wastewater revenues for Aqua Illinois and the revenues set in the last Aqua Illinois rate case.  We recognize revenues based on the target amount established in the last rate case, and then record either a regulatory asset or liability based on the cumulative annual difference between the target and actual, which results in either a refund due to customers or a payment from customers.  The cumulative annual difference is either refunded to customers or collected from customers over a nine-month period.  This revenue program represents a contract between the utility and its regulators, not customers, and therefore is not within the scope of the FASB’s accounting guidance for recognizing revenue from contracts with customers.    



Other and Eliminations – Other and eliminations consist of our market-based revenues, which comprises:  Aqua Infrastructure and Aqua Resources (described below), and intercompany eliminations for revenue billed between our subsidiaries. 



Aqua Infrastructure is the holding company for our 49% investment in a joint venture that operates a private pipeline system to supply raw water to natural gas well drilling operations in the Marcellus Shale of north central Pennsylvania.  The joint venture earns revenues through providing non-utility raw water supply services to natural gas drilling companies which enter into water supply contracts.  The performance obligation is to deliver non-potable water to the joint venture’s customers.  Aqua Infrastructure’s share of the revenues recognized by the joint venture is reflected, net, in equity earnings in joint venture on our consolidated statements of net income.   



Aqua Resources earns revenues by providing non-regulated water and wastewater services through operating and maintenance contracts, and third-party water and sewer service line repair.  The performance obligations are performing agreed upon services in the contract, most commonly operation of third-party water or wastewater treatment services, or billing services, or allowing the use of our logo

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to a third-party water and sewer service line repair.  Revenues are primarily recognized over time as service is delivered.



Note 3 – Goodwill 



The following table summarizes the changes in the Company’s goodwill, by business segment:

 





The reclassification of goodwill to utility plant acquisition adjustment results from a mechanism approved by the applicable utility commission.  The mechanism provides for the transfer over time, and the recovery through customer rates, of goodwill associated with some acquisitions upon achieving specific objectives.



Goodwill is not amortized but is tested for impairment annually, or more often, if circumstances indicate it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  When testing goodwill for impairment, the Company may assess qualitative factors, including macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, and entity specific events, for some or all of our reporting units to determine whether it’s more likely than not that the fair value of a reporting unit is less than its carrying amount.   Alternatively, based on our assessment of the qualitative factors previously noted, we may perform a quantitative goodwill impairment test by determining the fair value of a reporting unit based on a discounted cash flow analysis.  If we perform a quantitative test and determine that the fair value of a reporting unit is less than its carrying amount, we would record an impairment loss for the amount by which a reporting unit’s carrying amount exceeds its fair value, not to exceed the carrying amount of goodwill.  The Company performed a qualitative assessment for its annual test of the goodwill attributable for each of its reporting units for impairment as of July 31, 2018, and concluded that the estimated fair value of each reporting unit, which has goodwill recorded, exceeded the reporting unit’s carrying amount, indicating that none of the Company’s goodwill was impaired.







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Note 4 – Acquisitions 



Subsequent to the quarterly period ended September 30, 2018, pursuant to the Company’s growth strategy, on October 22, 2018, the Company entered into a purchase agreement with LDC Parent LLC (“Seller”), to acquire its interests in LDC Funding LLC (“LDC”).  LDC is the parent of LDC Holdings LLC (“LDC Holdings”), and LDC Holdings is the parent of five natural gas public utility companies, which includes Peoples Natural Gas Company, Peoples Gas Company, and Delta Natural Gas Company as well as other operating subsidiaries.  Collectively these businesses are referred to as “Peoples,” a natural gas distribution company headquartered in Pittsburgh, Pennsylvania, serving approximately 740,000 gas utility customers in Western Pennsylvania, West Virginia, and Kentucky.  The Company will acquire LDC for $4,275,000,  which will be reduced by the amount of outstanding indebtedness at closing, which is estimated to approximate $1,300,000.  The Company expects to finance this acquisition and refinance certain debt with a mix of common equity, mandatory convertible equity units, debt financing, which could include senior notes issued in capital markets transactions, term loans or other credit facilities or any combination thereof.  On October 23,  2018, the Company entered into interest rate swap agreements which locked in the interest rate for an anticipated $850,000 of future debt issuances related to this acquisition.  The interest rate swaps do not qualify for hedge accounting and any changes in the fair value of the swaps will be included in our future earnings.  The purchase price for this pending acquisition is subject to certain other adjustments at closing, and is subject to regulatory approval by the United States Federal Trade Commission, and the public utility commissions in Pennsylvania, Kentucky, and West Virginia.    This acquisition is expected to close in mid-2019, once regulatory approvals are obtained, and it is anticipated that this transaction will result in the recording of goodwill.  In the event that this acquisition is terminated a fee of $120,000 would be payable to the Seller.   



In July 2018, the Company acquired the wastewater utility systems assets of Limerick Township, Pennsylvania which serves 5,497 customers.  The total cash purchase price for the utility system was $74,836.  The purchase price allocation for this acquisition consisted primarily of acquired property, plant and equipment of $64,759,  and goodwill of $11,297.    Additionally, during the first nine months of 2018, the Company completed four acquisitions of water and wastewater utility systems in various states adding 4,338 customers.  The total purchase price of these utility systems consisted of $25,190 in cash.  The purchase price allocation for these acquisitions consisted primarily of acquired property, plant and equipment.  The pro forma effect of the businesses acquired is not material either individually or collectively to the Company’s results of operations.



In July 2018, the Company entered into a purchase agreement to acquire the wastewater utility system assets of Cheltenham Township, Pennsylvania, which serves approximately 10,500 customers for $50,250.  The purchase price for this pending acquisition is subject to certain adjustments at closing, and is subject to regulatory approval, including the final determination of the fair value of the rate base acquired. 



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In addition to the Company’s pending acquisition in Cheltenham Township, Pennsylvania, as part of the Company’s growth-through-acquisition strategy, the Company entered into purchase agreements to acquire the water or wastewater utility system assets of seven municipalities for a total combined purchase price in cash of $65,418 which we plan to finance by the issuance of debt.  The purchase price for these acquisitions is subject to certain adjustments at closing, and the acquisitions are subject to regulatory approvals, including the final determination of the fair value of the rate base acquired.  In October 2018, we closed on the following acquisition:



   

Closings for our remaining acquisitions are expected to occur by the end of 2019, subject to the timing of the regulatory approval process.  In total, these acquisitions will add approximately 10,800 customers in three of the states in which the Company operates in.   



During 2017, the Company completed four acquisitions of water and wastewater utility systems in various states adding 1,003 customers.  The total purchase price of these utility systems consisted of $5,860 in cash, which resulted in $72 of goodwill being recorded.  The pro forma effect of the businesses acquired is not material either individually or collectively to the Company’s results of operations. 



Note 5 –  Assets Held for Sale



In the first quarter of 2017, the Company decided to market for sale a water system that serves approximately 265 customers.  This water system is reported as assets held for sale in the Company’s consolidated balance sheet.  The Company has been in discussions with a potential buyer for the water system and is currently negotiating the terms of a sale, which will require regulatory approval.  



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Note 6 – Capitalization



In June 2018, the Company amended its unsecured revolving credit facility, to extend the expiration from February 2021 to June 2023, and to increase the facility from $250,000 to $500,000.  Funds borrowed under this facility are classified as long-term debt and are used to provide working capital as well as support for letters of credit for insurance policies and other financing arrangements.  Interest under this facility is based at the Company’s option, on the prime rate, an adjusted Euro-Rate, an adjusted federal funds rate or at rates offered by the banks.  A facility fee is charged on the total commitment amount of the agreement.



In June 2018, Aqua Pennsylvania issued $100,000 of first mortgage bonds, of which $25,000 is due in 2042,  $10,000 is due in 2045, and $65,000 is due in 2048 with interest rates of 3.99%,  4.04%, and 4.09%, respectively.  The proceeds from these bonds were used to repay existing indebtedness and for general corporate purposes.



In July 2018, Aqua Pennsylvania redeemed $49,660 of tax-exempt bonds at 5.25% that were originally maturing in 2042 and 2043, respectively.     



Note 7 – Financial Instruments 

 

The Company follows the FASB’s accounting guidance for fair value measurements and disclosures, which defines fair value and establishes a framework for using fair value to measure assets and liabilities.  That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value.  The hierarchy gives highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).  The three levels of the fair value hierarchy are as follows:





The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.  Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.  There have been no changes in the valuation techniques used to measure fair value, or asset or liability transfers between the levels of the fair value hierarchy for the quarter ended September 30, 2018. 



Financial instruments are recorded at carrying value in the financial statements and approximate fair value as of the dates presented.  The fair value of these instruments is disclosed below in accordance with current accounting guidance related to financial instruments. 

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The fair value of loans payable is determined based on its carrying amount and utilizing Level 1 methods and assumptions.  As of September 30, 2018 and December 31, 2017, the carrying amount of the Company’s loans payable was $21,689 and $3,650, respectively, which equates to their estimated fair value.  The fair value of cash and cash equivalents, which is comprised of uninvested cash, is determined based on the net asset value per unit utilizing Level 1 methods and assumptions.  As of September 30, 2018 and December 31, 2017, the carrying amounts of the Company's cash and cash equivalents was $4,264 and $4,204, respectively, which equates to their fair value.  The Company’s assets underlying the deferred compensation and non-qualified pension plans are determined by the fair value of mutual funds, which are based on quoted market prices from active markets utilizing Level 1 methods and assumptions.  As of September 30, 2018 and December 31, 2017, the carrying amount of these securities was $22,215 and $21,776,  respectively, which equates to their fair value, and is reported in the consolidated balance sheet in deferred charges and other assets. 



Unrealized gain and losses on equity securities held in conjunction with our non-qualified pension plan is as follows:







The net gain recognized on equity securities is presented on the consolidated statements of net income on the line item “Other.”  Additionally, the unrealized gain recognized during the three and nine months ended September 30, 2017, was reported on the consolidated statements of comprehensive income. 



The carrying amounts and estimated fair values of the Company’s long-term debt is as follows:

 



The fair value of long-term debt has been determined by discounting the future cash flows using current market interest rates for similar financial instruments of the same duration utilizing Level 2 methods and assumptions. 



The Company’s customers’ advances for construction have a carrying value of $94,112 as of September 30, 2018, and $93,186 as of December 31, 2017.  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 rates.  Portions of these non-interest bearing instruments are payable annually through 2028 and amounts not paid by the respective contract

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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 8 – Net Income per Common Share 

 

Basic net income per common share is based on the weighted average number of common shares outstanding.  Diluted net income per common share is based on the weighted average number of common shares outstanding and potentially dilutive shares.  The dilutive effect of employee stock-based compensation is included in the computation of diluted net income per common share.  The dilutive effect of stock-based compensation is calculated using the treasury stock method and expected proceeds upon exercise or issuance of the stock-based compensation.  The treasury stock method assumes that the proceeds from stock-based compensation are used to purchase the Company’s common stock at the average market price during the period.  The following table summarizes the shares, in thousands, used in computing basic and diluted net income per common share: 





For the three months ended September 30, 2018 and 2017 and the nine months ended September 30, 2017, all the Company’s employee stock options were included in the calculations of diluted net income per share as the calculated cost to exercise the stock options was less than the average market price of the Company’s common stock during these periods.  For the nine months ended September 30, 2018, employee stock options to purchase 8,596 shares of common stock were excluded from the calculation of diluted net income per share as the calculated cost to exercise the stock options was greater than the average market price of the Company’s common stock during this period.    

 

Note 9 – Stock-based Compensation 

 

Under the Company’s 2009 Omnibus Equity Compensation Plan, as amended as of February 27, 2014 (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.  No further grants may be made under the 2004 Plan.  The 2009 Plan authorizes 6,250,000 shares for issuance under the plan.  A maximum of 3,125,000 shares under the 2009 Plan may be issued pursuant to stock awards, stock units and other stock-based awards, subject to adjustment as provided in the 2009 Plan.  During any calendar year, no individual may be granted (i) stock options and stock appreciation rights under the 2009 Plan for more than 500,000 shares of Company stock in the aggregate or (ii) stock awards, stock units or other stock-based awards under the 2009 Plan for more than 500,000 shares of Company stock in the aggregate, subject to adjustment as provided in the 2009 Plan.  Awards to employees and consultants under the 2009 Plan are made by a committee of the Board of

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Directors of the Company, except that with respect to awards to the Chief Executive Officer, the committee recommends those awards for approval by the non-employee directors of the Board of Directors.  In the case of awards to non-employee directors, the Board of Directors makes such awards.  At September 30, 2018, 3,388,594 shares were still available for issuance under the 2009 Plan.   

 

Performance Share Units – A performance share unit (“PSU”) represents the right to receive a share of the Company’s common stock if specified performance goals are met over the three-year performance period specified in the grant, subject to exceptions through the respective vesting period, generally three years.  Each grantee is granted a target award of PSUs, and may earn between 0% and 200% of the target amount depending on the Company’s performance against the performance goals.  The following table provides compensation costs for stock-based compensation related to PSUs: 



 

The following table summarizes the PSU transactions for the nine months ended September 30, 2018:   



 

 

 

A portion of the fair value of PSUs was estimated at the grant date based on the probability of satisfying the market-based conditions using the Monte Carlo valuation method, which assesses probabilities of various outcomes of market conditions.  The other portion of the fair value of the PSUs is based on the fair market value of the Company’s stock at the grant date, regardless of whether the market-based condition is satisfied.  The per unit weighted-average fair value at the date of grant for PSUs granted during the nine months ended September 30, 2018 and 2017 was $37.42 and $30.79, respectively.  The fair value of each PSU grant is amortized monthly into compensation expense on a straight-line basis over their respective vesting periods, generally 36 months.  The accrual of compensation costs is based on the Company’s estimate of the final expected value of the award, and is adjusted as required for the portion based on the performance-based condition.  The Company assumes that forfeitures will be minimal, and recognizes forfeitures as they occur, which results in a reduction in compensation expense.  As the payout of the PSUs includes dividend equivalents, no separate dividend yield assumption is

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required in calculating the fair value of the PSUs.  The recording of compensation expense for PSUs has no impact on net cash flows.   



Restricted Stock Units – A restricted stock unit (“RSU”) represents the right to receive a share of the Company’s common stock.  RSUs are eligible to be earned at the end of a specified restricted period, generally three years, beginning on the date of grant.  The Company assumes that forfeitures will be minimal, and recognizes forfeitures as they occur, which results in a reduction in compensation expense.  As the payout of the RSUs includes dividend equivalents, no separate dividend yield assumption is required in calculating the fair value of the RSUs.  The following table provides the compensation cost and income tax benefit for stock-based compensation related to RSUs: