UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2005 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 (I.R.S. Employer Identification No.) incorporation or organization) 762 W. Lancaster Avenue, Bryn Mawr, Pennsylvania 19010-3489 - ------------------------------------------------ -------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (610) 527-8000 -------------- Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered ------------------- ------------------------ Common stock, par value $.50 per share New York Stock Exchange, Inc. Philadelphia Stock Exchange Inc. Securities registered pursuant to Section 12(g) of the Act: None. Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No --- --- Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No x --- --- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12(b)-2 of the Exchange Act: Large accelerated filer x Accelerated filer Non-accelerated filer ---------- ------ ------- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No x --- --- The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2005: $2,837,883,767 For purposes of determining this amount only, registrant has defined affiliates as including (a) the executive officers named in Part I of this 10-K report, (b) all directors of registrant, and (c) each shareholder that has informed registrant by June 30, 2005, that it has sole or shared voting power of 5% or more of the outstanding common stock of registrant. The number of shares outstanding of each of the registrant's classes of common stock as of February 17, 2006: 129,205,090 DOCUMENTS INCORPORATED BY REFERENCE (1) Portions of registrant's 2005 Annual Report to Shareholders have been incorporated by reference into Parts I and II of this Form 10-K Report. (2) Portions of the Proxy Statement, relative to the May 17, 2006 annual meeting of shareholders of registrant, to be filed within 120 days after the end of the fiscal year covered by this Form 10-K Report, have been incorporated by reference into Part III of this Form 10-K Report.
TABLE OF CONTENTS Part I Page ---- Item 1. Business 4 Item 1A. Risk Factors 14 Item 1B. Unresolved Staff Comments 17 Item 2. Properties 17 Item 3. Legal Proceedings 17 Item 4. Submission of Matters to a Vote of Security Holders 17 Part II Item 5. Market for the Registrant's Common Stock, Related Stockholder Matters and Purchases of Equity Securities 18 Item 6. Selected Financial Data 19 Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations 19 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 20 Item 8. Financial Statements and Supplementary Data 20 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 20 Item 9A. Controls and Procedures 20 Item 9B. Other Information 21 Part III Item 10. Directors and Executive Officers of the Registrant 21 Item 11. Executive Compensation 23 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 23 Item 13. Certain Relationships and Related Transactions 23 Item 14. Principal Accountant Fees and Services 24 Part IV Item 15. Exhibits and Financial Statement Schedules 24 Signatures 25 Exhibit Index 27
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain statements in this Annual Report on Form 10-K ("10-K"), or incorporated by reference into this 10-K, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that are made based upon, among other things, our current assumptions, expectations and beliefs concerning future developments and their potential effect on us. These forward-looking statements involve risks, uncertainties and other factors, many of which are outside our control, that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. In some cases you can identify forward-looking statements where statements are preceded by, followed by or include the words "believes," "expects," "anticipates," "plans," "future," "potential," "probably" or the negative of such terms or similar expressions. Forward-looking statements in this 10-K, or incorporated by reference into this 10-K, include, but are not limited to, statements regarding: o projected capital expenditures and related funding requirements; o developments, trends and consolidation in the water and wastewater utility industries; o dividend payment projections; o opportunities for future acquisitions, the success of pending acquisitions and the impact of future acquisitions; o the capacity of our water supplies, water facilities and wastewater facilities; o the impact of geographic diversity on our exposure to unusual weather; o our capability to pursue timely rate increase requests; o our authority to carry on our business without unduly burdensome restrictions; o our ability to obtain fair market value for condemned assets; o the impact of fines and penalties; o the development of new services and technologies by us or our competitors; o the availability of qualified personnel; o the condition of our assets; o the impact of legal proceedings; o general economic conditions; o acquisition-related costs and synergies; and o the forward-looking statements contained under the heading "Forward-Looking Statements" in the section entitled "Management's Discussion and Analysis" from the portion of our 2005 Annual Report to Shareholders incorporated by reference herein and made a part hereof. Because forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including but not limited to: o changes in general economic, business and financial market conditions; o changes in government regulations and policies, including environmental and public utility regulations and policies; 2
o changes in environmental conditions, including those that result in water use restrictions; o abnormal weather conditions; o changes in, or unanticipated, capital requirements; o changes in our credit rating; o our ability to integrate businesses, technologies or services which we may acquire; o our ability to manage the expansion of our business; o the extent to which we are able to develop and market new and improved services; o the effect of the loss of major customers; o our ability to retain the services of key personnel and to hire qualified personnel as we expand; o labor disputes; o increasing difficulties in obtaining insurance and increased cost of insurance; o cost overruns relating to improvements or the expansion of our operations; o increases in the costs of goods and services; o civil disturbance or terroristic threats or acts; and o changes in accounting policies. Given these uncertainties, you should not place undue reliance on these forward-looking statements. You should read this 10-K and the documents that we incorporate by reference into this 10-K completely and with the understanding that our actual future results may be materially different from what we expect. These forward-looking statements represent our estimates and assumptions only as of the date of this 10-K. Except for our ongoing obligations to disclose material information under the federal securities laws, we are not obligated to update these forward-looking statements, even though our situation may change in the future. For further information or other factors which could affect our financial results and such forward-looking statements, see "Risk Factors." We qualify all of our forward-looking statements by these cautionary statements. 3
PART I Item 1. Business The Company Aqua America, Inc. (referred to as "Aqua America", "we" or "us") is the holding company for regulated utilities providing water or wastewater services to approximately 2.5 million people in Pennsylvania, Ohio, North Carolina, Illinois, Texas, New Jersey, Florida, Indiana, Virginia, Maine, Missouri, New York and South Carolina. Our largest operating subsidiary, Aqua Pennsylvania, Inc., accounts for approximately 56% of our operating revenues for 2005 and as of December 31, 2005, provides water or wastewater services to approximately one-half of the total number of people we serve, located in the suburban areas north and west of the City of Philadelphia and in 22 other counties in Pennsylvania. Our other subsidiaries provide similar services in 12 other states. In addition, we provide water and wastewater service through operating and maintenance contracts with municipal authorities and other parties close to our operating companies' service territories. We are the largest U.S.-based publicly-traded water utility based on number of people served. The following table reports our operating revenues by principal state for the year ended December 31, 2005: Operating Revenues (000's) --------- Pennsylvania $279,691 Ohio 39,839 Texas 37,953 Illinois 35,300 North Carolina 29,840 New Jersey 22,588 Indiana 16,867 Florida 15,286 Maine 9,418 Virginia 8,337 Other states 1,660 -------- $496,779 ======== 4
The following table indicates by customer class our operating revenues for the year ended December 31, 2005: Operating Revenues Customer class (000's) --------- Residential water $295,473 Commercial water 73,455 Fire protection 21,861 Industrial water 18,364 Other water 28,966 -------- Water 438,119 Wastewater 42,176 Water and wastewater operating contracts and other 16,484 -------- $496,779 ======== Our customer base is diversified among residential, commercial, fire protection, industrial, other water, wastewater customers and operating contracts and other customers. Residential customers make up the largest component of our customer base, with these customers representing 67% of our total water revenues. Substantially all of our water customers are metered, which allows us to measure and bill for our customers' water consumption. Water consumption per customer is affected by local weather conditions during the year, especially during the late spring and early summer in our northern U.S. service territories. In general, during these seasons, an extended period of dry weather increases consumption, while above average rainfall decreases water consumption. Also, an increase in the average temperature generally causes an increase in water consumption. On occasion, abnormally dry weather in our service areas can result in governmental authorities declaring drought warnings and water use restrictions in the affected areas, which could reduce water consumption. See "Water Supplies, Water Facilities and Wastewater Facilities" for a discussion of water use restrictions that may impact water consumption during abnormally dry weather. The geographic diversity of our customer base reduces our exposure to extreme or unusual weather conditions in any one area of our service territory. Our growth in revenues over the past three years is a result of increases in our customer base and in water rates. The majority of the increase in customer base is due to customers added through acquisitions. During the three-year period of 2000 through 2002, our customer base increased at an annual compound rate of 3.3%. The customer growth rate in 2003 was 23.8%, and reflects the additional customers obtained in the AquaSource acquisition on July 31, 2003. In 2004, the customer growth rate was 11.5% and reflects the additional customers added through the Heater and Florida Water Services acquisitions. In 2005, the customer growth rate was 3.5%. Overall, for the five-year period of 2001 through 2005, our customer base increased at an annual compound rate of 8.9%. Acquisitions and Water Sale Agreements With approximately 50,000 community water systems in the U.S. (84% of which serve less than 3,300 customers), the water industry is the most fragmented of the major utility industries (telephone, natural gas, electric, water and wastewater). The nation's water systems range in size from large municipally-owned systems, such as the New York City water system that serves approximately 9 million people, to small systems, where a few customers share a common well. In the states where we operate, we believe there are over 22,000 public water systems of widely-varying size, with the majority of the population being served by government-owned water systems. 5
Although not as fragmented as the water industry, the wastewater industry in the U.S. also presents opportunities for consolidation. According to the U.S Environmental Protection Agency's ("EPA") most recent survey of publicly-owned wastewater treatment facilities in 2000, there are approximately 16,000 such facilities in the nation serving approximately 72% of the U.S. population. The remaining population represents individual homeowners with their own treatment facilities; for example, community on-lot disposal systems and septic tank systems. The vast majority of wastewater facilities are government-owned rather than privately-owned. The EPA survey also indicated that there are approximately 6,600 wastewater facilities in operation or planned in the 13 states where we operate. In 2005, we acquired a business providing on-site septic tank pumping and other services. This business presently serves approximately 2,000 customers in southeastern Pennsylvania and northern Delaware. Because of the fragmented nature of the water and wastewater utility industries, we believe that there are many potential water and wastewater system acquisition candidates throughout the United States. We believe the factors driving consolidation of these systems are: o the benefits of economies of scale; o increasingly stringent environmental regulations; o the need for capital investment; and o the need for technological and managerial expertise. We are actively exploring opportunities to expand our utility operations through acquisitions or other growth ventures. During the five-year period ended December 31, 2005, we completed 123 acquisitions or other growth ventures. We believe that acquisitions will continue to be an important source of growth for us. We intend to continue to pursue acquisitions of municipally-owned and investor-owned water and wastewater systems of all sizes that provide services in areas adjacent to our existing service territories or in new service areas. We engage in continuing activities with respect to potential acquisitions, including calling on prospective sellers, performing analyses and investigations of acquisition candidates, making preliminary acquisition proposals and negotiating the terms of potential acquisitions. Water Supplies, Water Facilities and Wastewater Facilities Our water utility operations obtain their water supplies from surface water sources such as reservoirs, lakes, ponds, rivers and streams, in addition to obtaining water from wells and purchasing water from other water suppliers. Less than 10% of our water sales are purchased from other suppliers. It is our policy to obtain and maintain the permits necessary to obtain the water we distribute. Our supplies by principal service area are as follows: o Pennsylvania - The principal supply of water is surface water from rural streams, rivers and reservoirs. Wells and interconnections with adjacent municipal authorities supplement these surface supplies. There are 11 surface water treatment plants. o Ohio - Water supply is obtained for customers in Lake County from Lake Erie. Customers in Mahoning County obtain their water from man-made lakes and the Ashtabula division is supplied by purchased water obtained through an interconnection with an adjacent water utility. Water supply is obtained for customers in Stark and Summit counties from wells. In Trumbull County, customers are served through an interconnection from our Pennsylvania division. o North Carolina - Water supply in 747 non-contiguous divisions is obtained principally from wells, with several divisions purchasing water from neighboring municipalities. o Illinois - Water supply is obtained for customers in Kankakee County from the Kankakee River and satellite wells, while customers in Vermilion County are supplied from Lake Vermilion. In Will, Lee, Boone, Lake and Knox counties, our customers are served from wells. In some areas, water supply is supplemented with purchased water obtained through interconnections with adjacent water utilities. o Texas - Water supply in 295 non-contiguous water systems is obtained principally from wells, supplemented in some cases by purchased water from adjacent surface water systems. 6
o Florida - Water supply in the majority of the 70 non-contiguous divisions is obtained principally from wells, supplemented in some cases by purchased water from adjacent surface water systems. o New Jersey - Water supply is obtained principally from wells and the supply is supplemented with purchased water obtained through interconnections with adjacent water utilities. o Indiana - Water supply in three water systems is obtained principally from wells. o Virginia - Water supply in 127 non-contiguous divisions is obtained from wells, one division's supply is from surface water, and four divisions supplement their supply with purchased water from a nearby water system. o Maine - Eleven non-contiguous water systems obtain their water supply as follows: six systems use groundwater, four systems use surface water and one system purchases water from a neighboring municipal district. We believe that the capacities of our sources of supply, and our water treatment, pumping and distribution facilities are generally sufficient to meet the present requirements of our customers under normal conditions. We plan system improvements and additions to capacity in response to changing regulatory standards, changing patterns of consumption and increased demand from a growing number of customers. The various state public utility commissions have generally recognized the operating and capital costs associated with these improvements in setting water rates. On occasion, drought warnings and water use restrictions are issued by governmental authorities for portions of our service territories in response to extended periods of dry weather conditions. The timing and duration of the warnings and restrictions can have an impact on our water revenues and net income. In general, water consumption in the summer months is affected by drought warnings and restrictions to a higher degree because nonessential and recreational use of water is at its highest during the summer months. At other times of the year, warnings and restrictions generally have less of an effect on water consumption. We believe that our wastewater treatment facilities are generally adequate to meet the present requirements of our customers. In addition, we own several sewer collection systems where the wastewater is treated at a municipally-owned facility. Capital funds are included in our capital plans to address inflow and infiltration in the collection systems, and wet weather flows at our lift stations and treatment plants, and other conditions and requirements that can affect compliance. Changes in regulatory requirements may be reflected in revised permit limits and conditions when National Pollution Discharge Elimination System ("NPDES") permits are renewed, typically on a five-year cycle. Capital improvements are planned and budgeted to meet anticipated changes in regulations and needs for increased capacity related to projected growth. The various state public utility commissions have generally recognized the operating and capital costs associated with these improvements in setting wastewater rates for current customers and capacity charges for new customers. Economic Regulation Most of our water and wastewater utility operations are subject to regulation by their respective state regulatory commissions, which have broad administrative power and authority to regulate rates and charges, determine franchise areas and conditions of service, approve acquisitions and authorize the issuance of securities. The regulatory commissions also establish uniform systems of accounts and approve the terms of contracts with affiliates and customers, business combinations with other utility systems, loans and other financings, and the franchise areas that we serve. A small number of our operations are subject to rate regulation by county or city governments. The profitability of our utility operations is influenced to a great extent by the timeliness and adequacy of rate allowances we are granted by the respective regulatory commissions or authorities in the various states in which we operate. 7
Accordingly, we maintain a rate case management capability to provide that the tariffs of our utility operations reflect, to the extent practicable, the timely recovery of increases in costs of operations, capital, taxes, energy, materials and compliance with environmental regulations. We file rate increase requests to recover the capital investments that we make in improving or replacing our facilities and to recover expenses. In the states in which we operate, we are subject to economic regulation by the following state regulatory commissions: State Regulatory Commission ----- --------------------- Pennsylvania Pennsylvania Public Utility Commission Ohio The Public Utilities Commission of Ohio North Carolina North Carolina Utilities Commission Illinois Illinois Commerce Commission Texas Texas Commission on Environmental Quality New Jersey New Jersey Board of Public Utilities Florida Florida Public Service Commission Indiana Indiana Utility Regulatory Commission Virginia Virginia State Corporation Commission Maine Maine Public Utilities Commission Missouri Missouri Public Service Commission New York New York Public Service Commission South Carolina South Carolina Public Service Commission Some of the states in which we acquired operations in 2004 and 2003 require separate rate filings for each of our local systems, as compared to a single state-wide rate filing. Between August 2003 and December 2005, we filed or were preparing to file rate filings in over 25 jurisdictions. Due to the length of time since the last rate increase for some acquired systems and the large amount of capital improvements relative to the number of customers in some smaller systems, the proposed rate increase in some of these systems may be substantial. While each of these rate filings will proceed through the applicable regulatory process, we can provide no assurance that the rate increases will be granted in a timely or sufficient manner to cover the investments and expenses for which we initially sought the rate increases. Further, there remains 116 divisions within these recently acquired operations where we have not yet filed a rate request. We are currently consolidating our customer service locations into three principal call centers, implementing a common customer information system, and upgrading our financial information systems. We expect to complete our primary customer service initiatives by the end of 2006. Consistent with prior practice, we have capitalized costs and services associated with the projects and expect to recover these costs in future rates. Although we believe it is probable that the applicable public utility commissions will allow recovery of these costs, we can provide no assurances as to their full recoverability until the conclusion of the applicable rate proceeding. Five states in which we operate permit water utilities, and in some states wastewater utilities, to add a surcharge to their water or wastewater bills to offset the additional depreciation and capital costs associated with certain capital expenditures related to replacing and rehabilitating infrastructure systems. Prior to these mechanisms being approved, water and wastewater utilities absorbed all of the depreciation and capital costs of these projects between base rate increases without the benefit of additional revenues. The gap between the time that a capital project is completed and the recovery of its costs in rates is known as regulatory lag. The infrastructure rehabilitation surcharge mechanism is intended to substantially reduce regulatory lag, which often acted as a disincentive to water and wastewater utilities to rehabilitate their infrastructure. In addition, our subsidiaries in certain states use a surcharge or credit on their bill to reflect changes in certain costs, such as changes in state tax rates, until such time as the costs are incorporated into base rates. Currently, Pennsylvania, Illinois, Ohio, Indiana and Missouri allow for the use of infrastructure rehabilitation surcharges. These mechanisms typically adjust periodically based on additional qualified capital expenditures completed or anticipated in a future period. The infrastructure rehabilitation surcharge is capped at a percentage of base rates, generally at 5% to 9% of base rates, and is reset to zero when new base rates that reflect the costs of those additions become effective or when a utility's earnings exceed a regulatory benchmark. Infrastructure rehabilitation surcharges provided revenues of $10,186,000 in 2005, $7,817,000 in 2004 and $8,147,000 in 2003. 8
In general, we believe that Aqua America, Inc. and its subsidiaries have valid authority, free from unduly burdensome restrictions, to enable us to carry on our business as presently conducted in the franchised or contracted areas we now serve. The rights to provide water or wastewater service to a particular franchised service territory are generally non-exclusive, although the applicable regulatory commissions usually allow only one regulated utility to provide service to a given area. In some instances, another water utility provides service to a separate area within the same political subdivision served by one of our subsidiaries. In the states where our subsidiaries operate, it is possible that portions of our subsidiaries' operations could be acquired by municipal governments by one or more of the following methods: o eminent domain; o the right of purchase given or reserved by a municipality or political subdivision when the original franchise was granted; and o the right of purchase given or reserved under the law of the state in which the subsidiary was incorporated or from which it received its permit. The price to be paid upon such an acquisition by the municipal government is usually determined in accordance with applicable law governing the taking of lands and other property under eminent domain. In other instances, the price may be negotiated, fixed by appraisers selected by the parties or computed in accordance with a formula prescribed in the law of the state or in the particular franchise or charter. We believe that our operating subsidiaries will be entitled to fair market value for any assets that are condemned, and we believe the fair market value will be in excess of the book value for such assets. In December 2004, as a result of the settlement of a condemnation action, our Ohio operating subsidiary sold its water utility assets within the municipal boundaries of the City of Geneva in Ashtabula County, Ohio for net proceeds of approximately $4,716,000, which was in excess of the book value for these assets. The sale resulted in the recognition in the fourth quarter of 2004 of a pre-tax gain on the sale of these assets, net of expenses, of $2,342,000. We continue to operate this water system for the City of Geneva under an operating contract that began upon the closing of the sale for a period through December 2006. These water utility assets represent less than 1% of Aqua America's total assets, and the total number of customers included in the water system sold represents less than 1% of our total customer base. The increase in earnings associated with reinvesting the sale's proceeds and the operating income generated by the operating contract has offset the loss of this water system's historic contribution to income. The City of Fort Wayne, Indiana has authorized the acquisition, by eminent domain or otherwise, of a portion of the utility assets of one of the operating subsidiaries that we acquired in connection with the AquaSource acquisition in 2003. We have challenged whether the City is following the correct legal procedures in connection with the City's attempted condemnation and we have challenged the City's valuation of this portion of our system. The portion of the system under consideration represents approximately 1% of our total customer base. While we continue to discuss this matter with officials from the City of Fort Wayne, we continue to protect our interests in this proceeding. Despite the sales and possible condemnation referred to above, our strategy continues to be to acquire additional water and wastewater systems, maintain our existing systems, and actively oppose efforts by municipal governments to acquire any of our operations, particularly for less than the fair market value of our operations or where the municipal government seeks to acquire more than it is entitled to under the applicable law or agreement. 9
Environmental, Health and Safety Regulation Provision of water and wastewater services is subject to regulation under the federal Safe Drinking Water Act, the Clean Water Act and related state laws, and under federal and state regulations issued under these laws. These laws and regulations establish criteria and standards for drinking water and for wastewater discharges. In addition, we are subject to federal and state laws and other regulations relating to solid waste disposal, dam safety and other operations. Capital expenditures and operating costs required as a result of water quality standards and environmental requirements have been traditionally recognized by state public utility commissions as appropriate for inclusion in establishing rates. Environmental compliance issues remain at various water and wastewater facilities associated with acquired systems, including facilities acquired in connection with the AquaSource acquisition that was completed in 2003, the Heater and Florida Water Service acquisitions completed in 2004 and the acquisitions of small utilities in Northeastern Pennsylvania. We believe that the capital expenditures required to address these compliance issues have been budgeted in our capital program and represent less than 10% of our expected total capital expenditures over the next five years. We are parties to agreements with regulatory agencies in Texas, Florida, Indiana, Virginia and North Carolina under which we have committed to make certain improvements for environmental compliance. These agreements are intended to provide the regulators with assurance that problems covered by these agreements will be addressed, and the agreements generally provide protection to us from fines, penalties and other actions while corrective measures are being implemented. We are actively working directly with state environmental officials to implement or amend these agreements as necessary. Safe Drinking Water Act - The Safe Drinking Water Act establishes criteria and procedures for the U.S. Environmental Protection Agency to develop national quality standards for drinking water. Regulations issued pursuant to the Safe Drinking Water Act and its amendments set standards on the amount of certain microbial and chemical contaminants and radionuclides allowable in drinking water. Current requirements under the Safe Drinking Water Act are not expected to have a material impact on our operations or financial condition as we have made and are making investments to meet existing water quality standards. We may, in the future, be required to change our method of treating drinking water at certain sources of supply if additional regulations become effective. The EPA's issuance of a rule regulating radon in tap water has been postponed repeatedly since 1991. Limits for radon in tap water, if promulgated, would probably become effective 4 or 5 years after promulgation and would likely contain two standards to recognize cost-effective alternative approaches to dealing with radon in indoor air. We anticipate that the higher level established by such a rule might require treatment at a small percentage of our wells, primarily in North Carolina, Pennsylvania and Virginia. If the states in which we operate elect not to implement general radon reduction (Multi-Media Mitigation) programs, then a more stringent limit for radon could apply and a larger number of wells would be affected. We anticipate that states will adopt Multi-Media Mitigation programs, and the capital costs to comply with this future regulation could approximate $4,000,000 over a five year period. The Safe Drinking Water Act provides for the regulation of radionuclides other than radon, such as radium and uranium. The Radionuclides Rule that became effective in December 2003 left unchanged the existing standards for gross alpha and radium, but changed the monitoring protocol. The rule also added a maximum contaminant level for uranium. Under the new testing protocols, some of our smaller groundwater facilities have exceeded one or more of the radionuclide standards and require treatment by January 2008. Treatment processes have already been installed at twelve facilities, and approximately twenty additional facilities will require the installation of a treatment process, replacement or modification of a well, or other remedy. The future capital cost of compliance is expected to be less than $5,000,000. The impact of the rulemaking is not expected to have a material impact on our results of operations or financial condition. 10
In order to remove or inactivate microbial organisms, rules were issued by the EPA to improve disinfection and filtration of potable water and reduce consumers' exposure to disinfectants and by-products of the disinfection process. In the future, we may be required to install filtration or other treatment, for one currently unfiltered surface water supply. The cost of this treatment, should it be required, is not expected to exceed $5,000,000. Certain small groundwater systems could be reclassified as being influenced by surface water. This may require additional treatment or the development of replacement sources of supply over time, the cost for which is not expected to exceed a total of $1,000,000. In addition, ten small systems in Florida were recently found to have trihalomethanes above the current maximum contaminant level. Treatment modifications are being planned that may require capital costs of approximately $1,500,000 over the next two years. The EPA promulgated the Long Term 2 Enhanced Surface Water Treatment Rule and a Stage 2 Disinfection/Disinfection By-product Rule in January 2006. These rules will result in additional one-time special monitoring costs of approximately $600,000 over a four-year period from 2006 to 2010. The results of the monitoring might require modification of treatment, including capital improvements, in year 2008 and beyond. It is not possible at this time to reasonably project the potential impact on the capital budget, if any, from these rules, but the impact is not expected to have a material impact on our results of operations or financial condition. A rule lowering the limit on arsenic was promulgated in 2001 and becomes effective in January 2006, with a provision for further time extensions for small systems. The rule will require installation of treatment or development of alternative supplies at a very limited number of our groundwater sources. The largest of these, in Pennsylvania, was equipped with treatment in 2004. A small system in Maine was equipped with treatment in 2005. One system each in Texas and Ohio will require treatment in 2006, and one system in North Carolina will require treatment or replacement of a currently unused back-up well. The cost of these remaining capital improvements to fully achieve compliance with this regulation is not expected to exceed $500,000. In 2000, the gasoline additive Methyl tert-Butyl Ether ("MtBE") was discovered in a production well in one of our operating subsidiaries at levels exceeding the state drinking water standard. The well was immediately taken out of service and alternate water supplies were obtained. A legal settlement was reached in 2004 with the company believed to be responsible for the contamination and we received a settlement amount of $2,000,000 to cover the cost of a permanent replacement well, which was completed and placed in service in 2004, and to cover our interim purchased water costs incurred. Traces of MtBE may be found throughout the environment as the result of extensive use of MtBE as a gasoline additive. Clean Water Act - The Clean Water Act regulates discharges from drinking water and wastewater treatment facilities into lakes, rivers, streams, and groundwater. It is our policy to obtain and maintain all required permits and approvals for the discharges from our water and wastewater facilities, and to comply with all conditions of those permits and other regulatory requirements. A program is in place to monitor facilities for compliance with permitting, monitoring and reporting for wastewater discharges. From time to time, discharge violations may occur which may result in fines. We are also parties to compliance agreements with regulatory agencies in several states where we operate while improvements are being made to address wastewater discharge compliance issues. These fines and penalties, if any, are not expected to have a material impact on our results of operations or financial condition. The required costs to comply with the agreements previously cited are included in our capital program, are not expected to be significant, and are expected to be recoverable in rates. Recent changes in wastewater regulations in the state of Missouri will require improvements at certain of the 52 small wastewater systems we operate in that state. We presently estimate the cost of these improvements to be approximately $1,500,000 over the next three years. 11
Solid Waste Disposal - The handling and disposal of residuals and solid waste generated from water and wastewater treatment facilities is governed by federal and state laws and regulations. A program is in place to monitor our facilities for compliance with regulatory requirements, and we do not currently anticipate any major expenditures in connection with the handling and disposal of waste material from our water and wastewater operations. Dam Safety - Our subsidiaries own seventeen major dams that are subject to the requirements of the Federal and state regulations related to dam safety. All major dams undergo an annual engineering inspection. We believe that all seventeen dams are structurally sound and well-maintained. In Pennsylvania, the Department of Environmental Protection has adopted the use of a revised formula for determining the magnitude of a probable maximum flood. We have studied our dams to determine what improvements may be needed as a result of this new calculation. Our initial studies identified three dams in Pennsylvania that could require capital improvements; however, further study reduced this to two dams needing improvements of approximately $6,000,000 in the aggregate. Our findings have been accepted by the Department of Environmental Protection, and design is underway for both dam improvement projects. Construction is anticipated to be completed over the next three years, and we believe that these capital expenditures will be recoverable in our rates. Similarly, in Ohio, the Department of Natural Resources has adopted the use of a revised formula. We have studied our dams in Ohio and determined that three of the dams will require improvements. Construction began in 2005 on one of these dams, and we believe that capital expenditures of approximately $4,600,000 in the aggregate will be required on these dams over the next four years. Safety Standards - Our facilities and operations may be subject to inspections by representatives of the Occupational Safety and Health Administration from time to time. We maintain safety policies and procedures to comply with the Occupational Safety and Health Administration's rules and regulations, but violations may occur from time to time, which may result in fines and penalties, which are not expected to be material. We endeavor to correct such violations promptly after they are brought to our attention. Security In light of concerns regarding security in the wake of the September 11, 2001 terrorist attacks, we have increased security measures at our facilities. These increased security measures were not made in response to any specific threat. We are in contact with federal, state and local authorities and industry trade associations regarding information on possible threats and security measures for water utility operations. The cost of the increased security measures, including capital expenditures, is expected to be recoverable in water rates and is not expected to have a material impact on our results of operations or financial condition. Employee Relations As of December 31, 2005, we employed a total of 1,489 full-time employees. Our subsidiaries are parties to 10 agreements with labor unions covering 428 employees that expire at various times between March 2006 and May 2009. One of the agreements, representing 275 employees, expires in December 2006 and five additional contracts, representing 91 employees, expire at various other times in 2006. 12
Available Information We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission ("SEC"). You may read and copy any document we file with the SEC at the SEC's public reference room at 100 F. Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. You may also obtain our SEC filings from the SEC's Web site at www.sec.gov. Our Internet Web site address is http://www.aquaamerica.com. We make available free of charge through our Web site's Investor Relations page all of our filings with the SEC, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other information. These reports and information are available as soon as reasonably practicable after such material is electronically filed or furnished to the SEC. Our Board of Directors has various committees including an audit committee, an executive compensation and employee benefits committee and a corporate governance committee. Each of the three committees named above has a formal charter. We also have Corporate Governance Guidelines and a Code of Ethical Business Conduct. Copies of these charters, guidelines and codes, and any waivers or amendments to such codes which are applicable to our executive officers, senior financial officers or directors, can be obtained free of charge from our Web site, www.aquaamerica.com. In addition, you may request a copy of the foregoing filings, charters, guidelines and codes, and any waivers or amendments to such codes which are applicable to our executive officers, senior financial officers or directors, at no cost by writing or telephoning us at the following address or telephone number: Investor Relations Department Aqua America, Inc. 762 W. Lancaster Avenue Bryn Mawr, PA 19010-3489 Telephone: 610-527-8000 13
Item 1A. Risk Factors In addition to the other information included in this Report, the following factors should be considered in evaluating our business and future prospects. Any of the following risks, either alone or taken together, could materially and adversely affect our business, financial position or results of operations. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may vary materially from what we projected. There may be additional risks that we do not presently know or that we currently believe are immaterial which could also impair our business or financial position. OUR BUSINESS REQUIRES SIGNIFICANT CAPITAL EXPENDITURES AND THE RATES WE CHARGE OUR CUSTOMERS ARE SUBJECT TO REGULATION. IF WE ARE UNABLE TO OBTAIN SUFFICIENT CAPITAL ON REASONABLE TERMS OR OBTAIN GOVERNMENT APPROVAL OF OUR REQUESTS FOR RATE INCREASES, OR IF APPROVED RATE INCREASES ARE UNTIMELY OR INADEQUATE TO COVER OUR CAPITAL INVESTMENTS AND TO RECOVER EXPENSES, OUR PROFITABILITY MAY SUFFER. The water utility business is capital intensive. In addition to the capital required to fund our growth through acquisition strategy, on an annual basis, we spend significant sums for additions to or replacement of property, plant and equipment. Our ability to maintain and meet our financial objectives is dependent upon the availability of adequate capital and the recovery of our capital investments through the rates we charge our customers. There is no guarantee that we will be able to obtain sufficient capital in the future on reasonable terms and conditions for expansion, construction and maintenance. In the event we are unable to obtain sufficient capital, our expansion efforts could be curtailed, which may affect our growth and may affect our future results of operations. The rates we charge our customers are subject to approval by the public utility commissions or similar regulatory bodies in the states in which we operate. We file rate increase requests, from time to time, to recover our investments in utility plant and expenses. Once a rate increase petition is filed with a public utility commission, the ensuing administrative and hearing process may be lengthy and costly. The timing of our rate increase requests are therefore partially dependent upon the estimated cost of the administrative process in relation to the investments and expenses that we hope to recover through the rate increase to the extent approved. We can provide no assurances that any future rate increase request will be approved by the appropriate state public utility commission; and, if approved, we cannot guarantee that these rate increases will be granted in a timely or sufficient manner to cover the investments and expenses for which we initially sought the rate increase. OUR OPERATING COSTS COULD BE SIGNIFICANTLY INCREASED IN ORDER TO COMPLY WITH NEW OR STRICTER REGULATORY STANDARDS IMPOSED BY FEDERAL AND STATE ENVIRONMENTAL AGENCIES. Our water and wastewater services are governed by various federal and state environmental protection and health and safety laws and regulations, including the federal Safe Drinking Water Act, the Clean Water Act and similar state laws, and federal and state regulations issued under these laws by the United States Environmental Protection Agency and state environmental regulatory agencies. These laws and regulations establish, among other things, criteria and standards for drinking water and for discharges into the waters of the United States and states. Pursuant to these laws, we are required to obtain various environmental permits from environmental regulatory agencies for our operations. We cannot assure you that we have been or will be at all times in total compliance with these laws, regulations and permits. If we violate or fail to comply with these laws, regulations or permits, we could be fined or otherwise sanctioned by regulators. Environmental laws and regulations are complex and change frequently. These laws, and the enforcement thereof, have tended to become more stringent over time. While we have budgeted for future capital and operating expenditures to maintain compliance with these laws and our permits, it is possible that new or stricter standards could be imposed that will raise our operating costs. Although these costs may be recovered in the form of higher rates, there can be no assurance that the various state public utility commissions or similar regulatory bodies that govern our business would approve rate increases to enable us to recover such costs. In summary, we cannot assure you that our costs of complying with, or discharging liability under, current and future environmental and health and safety laws will not adversely affect our business, results of operations or financial condition. 14
OUR BUSINESS IS SUBJECT TO SEASONAL FLUCTUATIONS, WHICH COULD AFFECT DEMAND FOR OUR WATER SERVICE AND OUR REVENUES. Demand for our water during the warmer months is generally greater than during cooler months due primarily to additional requirements for water in connection with irrigation systems, swimming pools, cooling systems and other outside water use. Throughout the year, and particularly during typically warmer months, demand will vary with temperature and rainfall levels. In the event that temperatures during the typically warmer months are cooler than normal, or if there is more rainfall than normal, the demand for our water may decrease and adversely affect our revenues. DROUGHT CONDITIONS MAY IMPACT OUR ABILITY TO SERVE OUR CURRENT AND FUTURE CUSTOMERS, AND MAY IMPACT OUR CUSTOMERS' USE OF OUR WATER, WHICH MAY ADVERSELY AFFECT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS. We depend on an adequate water supply to meet the present and future demands of our customers. Drought conditions could interfere with our sources of water supply and could adversely affect our ability to supply water in sufficient quantities to our existing and future customers. An interruption in our water supply could have a material adverse effect on our financial condition and results of operations. Moreover, governmental restrictions on water usage during drought conditions may result in a decreased demand for our water, even if our water reserves are sufficient to serve our customers during these drought conditions, which may adversely affect our revenues and earnings. AN IMPORTANT ELEMENT OF OUR GROWTH STRATEGY IS THE ACQUISITION OF WATER AND WASTEWATER SYSTEMS. ANY FUTURE ACQUISITIONS WE DECIDE TO UNDERTAKE MAY INVOLVE RISKS. An important element of our growth strategy is the acquisition and integration of water and wastewater systems in order to broaden our current, and move into new, service areas. We will not be able to acquire other businesses if we cannot identify suitable acquisition opportunities or reach mutually agreeable terms with acquisition candidates. It is our intent, when practical, to integrate any businesses we acquire with our existing operations. The negotiation of potential acquisitions as well as the integration of acquired businesses could require us to incur significant costs and cause diversion of our management's time and resources. Future acquisitions by us could result in: o dilutive issuances of our equity securities; o incurrence of debt and contingent liabilities; o failure to have effective internal control over financial reporting; o fluctuations in quarterly results; and o other acquisition-related expenses. Some or all of these items could have a material adverse effect on our business and our ability to finance our business and comply with regulatory requirements. The businesses we acquire in the future may not achieve sales and profitability that would justify our investment, and any difficulties we encounter in the integration process, including in the integration of controls necessary for internal control and financial reporting, could interfere with our operations, reduce our operating margins and adversely affect our internal controls. In addition, as consolidation becomes more prevalent in the water and wastewater industries, the prices for suitable acquisition candidates may increase to unacceptable levels and limit our ability to grow through acquisitions. 15
CONTAMINATION TO OUR WATER SUPPLY MAY RESULT IN DISRUPTION IN OUR SERVICES AND LITIGATION WHICH COULD ADVERSELY AFFECT OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION. Our water supplies are subject to contamination, including contamination from the development of naturally-occurring compounds, chemicals in groundwater systems, pollution resulting from man-made sources, such as MtBE, and possible terrorist attacks. In the event that our water supply is contaminated, we may have to interrupt the use of that water supply until we are able to substitute the flow of water from an uncontaminated water source. In addition, we may incur significant costs in order to treat the contaminated source through expansion of our current treatment facilities, or development of new treatment methods. If we are unable to substitute water supply from an uncontaminated water source, or to adequately treat the contaminated water source in a cost-effective manner, there may be an adverse effect on our revenues, operating results and financial condition. The costs we incur to decontaminate a water source or an underground water system could be significant and could adversely affect our business, operating results and financial condition and may not be recoverable in rates. We could also be held liable for consequences arising out of human exposure to hazardous substances in our water supplies or other environmental damage. For example, private plaintiffs have the right to bring personal injury or other toxic tort claims arising from the presence of hazardous substances in our drinking water supplies. Our insurance policies may not be sufficient to cover the costs of these claims. In addition to the potential pollution of our water supply as described above, in the wake of the September 11, 2001 terrorist attacks and the ensuing threats to the nation's health and security, we have taken steps to increase security measures at our facilities and heighten employee awareness of threats to our water supply. We have also tightened our security measures regarding the delivery and handling of certain chemicals used in our business. We have and will continue to bear increased costs for security precautions to protect our facilities, operations and supplies. These costs may be significant. Despite these tightened security measures, we may not be in a position to control the outcome of terrorist events should they occur. WASTEWATER OPERATIONS MAY ENTAIL SIGNIFICANT RISKS. Wastewater collection and treatment involve many risks associated with damage to the surrounding environment. If collection or treatment systems fail or do not operate properly, untreated or partially treated wastewater could discharge onto property or into nearby streams and rivers, causing property damage or injury to aquatic life, or even human life. Liabilities resulting from such damage could materially and adversely affect the Company's results of operations and financial condition. WORK STOPPAGES AND OTHER LABOR RELATIONS MATTERS COULD ADVERSELY AFFECT OUR OPERATING RESULTS. Approximately 33% of our workforce, are unionized under ten labor contracts (or contracts under negotiation) with labor unions, which expire over several years. We believe our labor relations are good, but in light of rising costs for healthcare and pensions, contract negotiations in the future may be difficult. We are subject to a risk of work stoppages and other labor relations matters as we negotiate with the unions to address these issues, which could affect the Company's results of operations and financial condition. We cannot assure you that issues with our labor forces will be resolved favorably to us in the future or that we will not experience work stoppages. WE DEPEND SIGNIFICANTLY ON THE SERVICES OF THE MEMBERS OF OUR MANAGEMENT TEAM, AND THE DEPARTURE OF ANY OF THOSE PERSONS COULD CAUSE OUR OPERATING RESULTS TO SUFFER. Our success depends significantly on the continued individual and collective contributions of our management team. The loss of the services of any member of our management team or the inability to hire and retain experienced management personnel could harm our operating results. 16
Item 1B. Unresolved Staff Comments. None. Item 2. Properties. Our properties consist of transmission and distribution mains and conduits, water and wastewater treatment plants, pumping facilities, wells, tanks, meters, supply lines, dams, reservoirs, buildings, vehicles, land, easements, rights and other facilities and equipment used for the operation of our systems, including the collection, treatment, storage and distribution of water and the collection and treatment of wastewater. Substantially all of our properties are owned by our subsidiaries, and a substantial portion of our property is subject to liens of mortgage or indentures. These liens secure bonds, notes and other evidences of long-term indebtedness of our subsidiaries. For certain properties that we acquired through the exercise of the power of eminent domain and certain other properties we purchased, we hold title for water supply purposes only. We own, operate and maintain several thousand miles of transmission and distribution mains, 23 water treatment plants, and many well treatment stations and wastewater treatment plants. Some properties are leased under long-term leases. The following table indicates our net property, plant and equipment, in thousands of dollars, as of December 31, 2005 in the principal states where we operate: Net Property, Plant and Equipment ---------- Pennsylvania $1,337,190 Illinois 179,391 Ohio 176,296 Texas 160,880 North Carolina 140,126 New Jersey 117,999 Indiana 95,025 Florida 56,371 Maine 40,452 Virginia 37,850 Missouri 4,755 Inter-company eliminations and other states (66,385) ---------- $2,279,950 ========== We believe that our properties are generally maintained in good condition and in accordance with current standards of good waterworks industry practice. We believe that the facilities used in the operation of our business are in good condition in terms of suitability, adequacy and utilization. Our corporate offices are leased from Aqua Pennsylvania, Inc. and located in Bryn Mawr, Pennsylvania. Item 3. Legal Proceedings There are various legal proceedings in which we are involved. Although the results of legal proceedings cannot be predicted with certainty, there are no pending legal proceedings to which we or any of our subsidiaries is a party or to which any of our properties is the subject that are material or are expected to have a material effect on our financial position, results of operations or cash flows. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of 2005. 17
PART II Item 5. Market for the Registrant's Common Stock, Related Stockholder Matters and Purchases of Equity Securities Our common stock is traded on the New York Stock Exchange and the Philadelphia Stock Exchange under the ticker symbol WTR. As of February 17, 2006, there were approximately 27,457 holders of record of our common stock. The following table shows the high and low intraday sales prices for our common stock as reported on the New York Stock Exchange composite transactions reporting system and the cash dividends paid per share for the periods indicated (all per share data as presented has been adjusted for the 2005 4-for-3 common stock split effected in the form of a stock distribution): First Second Third Fourth Quarter Quarter Quarter Quarter Year ----------------------------------------------------------------- 2005 - --------------------------------------------------------------------------------------------------------------- Dividend paid per common share $0.0975 $0.0975 $0.0975 $0.1069 $0.3994 Dividend declared per common share 0.0975 0.0975 0.2044 - $0.3994 Price range of common stock - high 19.37 23.24 29.15 29.22 29.22 - low 17.49 18.03 21.61 22.88 17.49 2004 - --------------------------------------------------------------------------------------------------------------- Dividend paid per common share $ 0.09 $ 0.09 $ 0.09 $0.0975 $0.3675 Dividend declared per common share 0.09 0.09 0.1875 - 0.3675 Price range of common stock - high 17.14 16.47 16.67 18.48 18.48 - low 15.00 14.24 14.18 15.58 14.18 We have paid common dividends consecutively for 61 years. Effective December 1, 2005, our Board of Directors authorized an increase of 9.6% in the dividend rate over the amount Aqua America, Inc. paid in the previous quarter. As a result of this authorization, beginning with the dividend payment in December 2005, the annualized dividend rate increased to $0.4276 per share. We presently intend to pay quarterly cash dividends in the future, on March 1, June 1, September 1 and December 1, subject to our earnings and financial condition, regulatory requirements and such other factors as our Board of Directors may deem relevant. During the past five years, our common dividends paid have averaged 56.3% of net income. In August 2005, our Board of Directors declared a 4-for-3 common stock split effected in the form of a 33 1/3 % stock distribution for all common shares outstanding, to shareholders of record on November 17, 2005. The new shares were distributed on December 1, 2005. All share and per share data for all periods presented have been restated to give effect to the stock split. 18
The following table summarizes the Company's purchases of its common stock for the quarter ending December 31, 2005: 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) - ------ ------------ ---------- ---------- ----------- October 1-31, 2005 1,579 $ 27.55 - 548,278 November 1-30, 2005 720 $ 25.49 - 548,278 December 1-31, 2005 12,952 $ 26.71 - 548,278 ------------ ---------- ---------- ----------- Total 15,251 $ 26.74 - 548,278 ============ ========== ========== =========== (1) These amounts consist of 10,656 shares we purchased from shareholders for the fractional shares that would otherwise be issued in connection with the December 1, 2005 stock split, and shares we purchased from our 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 option grants under the plan and these shares are purchased at their fair market value, as determined by reference to the closing price of our common stock 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. Item 6. Selected Financial Data The information appearing in the section captioned "Summary of Selected Financial Data" from the portions of our 2005 Annual Report to Shareholders filed as Exhibit 13.1 to this Form 10-K Report is incorporated by reference herein. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information appearing in the section captioned "Management's Discussion and Analysis" from the portions of our 2005 Annual Report to Shareholders filed as Exhibit 13.1 to this Form 10-K Report is incorporated by reference herein. 19
Item 7A. 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. The exposure to changes in interest rates is a result of financings through the issuance of fixed-rate, long-term debt. Such exposure is typically related to financings between utility rate increases, since generally our rate increases include a revenue level to allow recovery of our current cost of capital. Interest rate risk is managed through the use of a combination of long-term debt, which is at fixed interest rates and short-term debt, which is at floating interest rates. As of December 31, 2005, the debt maturities by period, in thousands of dollars, and the weighted average interest rate for fixed-rate, long-term debt are as follows: Fair 2006 2007 2008 2009 2010 Thereafter Total Value - --------------------------------------------------------------------------------------------------------------------- Long-term debt (fixed rate) $24,645 $30,959 $23,651 $ 6,672 $53,884 $ 763,272 $903,083 $950,479 Weighted average interest rate 5.74% 5.64% 5.63% 5.72% 5.44% 5.35% 5.74% From time to time, we make investments in marketable equity securities. As a result, we are exposed to the risk of changes in equity prices for the "available-for-sale" marketable equity securities. As of December 31, 2005, we owned no marketable equity securities as we sold the balance of our securities during 2004. Item 8. Financial Statements and Supplementary Data Information appearing under the captions "Consolidated Statements of Income and Comprehensive Income", "Consolidated Balance Sheets", "Consolidated Cash Flow Statements", "Consolidated Statements of Capitalization", "Consolidated Statements of Common Stockholders' Equity" and "Notes to Consolidated Financial Statements" from the portions of our 2005 Annual Report to Shareholders filed as Exhibit 13.1 to this Form 10-K Report is incorporated by reference herein. Also, the information appearing in the sections captioned "Management's Report on Internal Control Over Financial Reporting" and "Report of Independent Registered Public Accounting Firm" from the portions of our 2005 Annual Report to Shareholders filed as Exhibit 13.1 to this Form 10-K Report is incorporated by reference herein. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. Item 9A. 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 to provide reasonable assurance 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. A controls system cannot provide absolute assurance, however, that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. (b) Management's Report on Internal Control Over Financial Reporting - The information appearing in the section captioned "Management's Report on Internal Control Over Financial Reporting" from the portions of our 2005 Annual Report to Shareholders filed as Exhibit 13.1 to this Form 10-K Report is incorporated by reference herein. 20
(c) 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. Item 9B. Other Information None. PART III Item 10. Directors and Executive Officers of the Registrant We make available free of charge within the Investor Relations / Corporate Governance section of our Internet Web site, at www.aquaamerica.com, and in print to any shareholder who requests, our Corporate Governance Guidelines, the Charters of each Committee of our Board of Directors, and our Code of Ethical Business Conduct. Requests for copies may be directed to Investor Relations Department, Aqua America, Inc., 762 W. Lancaster Avenue, Bryn Mawr, PA 19010-3489. Amendments to the Code, and any grant of a waiver from a provision of the Code requiring disclosure under applicable SEC rules will be disclosed on the Company's Web site. The information contained on our Web site is not incorporated by reference into this Form 10-K and should not be considered part of this or any other report that we file with or furnish to the SEC. Directors of the Registrant, Audit Committee, Audit Committee Financial Expert and Filings under Section 16(a) The information appearing in the sections captioned "Information Regarding Nominees and Directors", "Corporate Governance" and "Section 16(a) Beneficial Ownership Reporting Compliance" of the Proxy Statement relating to our May 17, 2006, annual meeting of shareholders, to be filed within 120 days after the end of the fiscal year covered by this Form 10-K Report, is incorporated herein by reference. 21
Executive Officers of the Registrant The following table and the notes thereto set forth information with respect to our executive officers, including their names, ages, positions with Aqua America, Inc. and business experience during the last five years: Position with Name Age Aqua America, Inc. (1) - ---- --- ---------------------- Nicholas DeBenedictis 60 Chairman, President and Chief Executive Officer (May 1993 to present); President and Chief Executive Officer (July 1992 to May 1993); Chairman and Chief Executive Officer, Aqua Pennsylvania, Inc. (July 1992 to present); President, Philadelphia Suburban Water Company (February 1995 to January 1999) (2) Roy H. Stahl 53 Executive Vice President and General Counsel (May 2000 to present); Secretary (June 2001 to present); Senior Vice President and General Counsel (April 1991 to May 2000) (3) David P. Smeltzer 47 Senior Vice President - Finance and Chief Financial Officer (December 1999 to present); Vice President - Finance and Chief Financial Officer (May 1999 to December 1999); Vice President - Rates and Regulatory Relations, Philadelphia Suburban Water Company (March 1991 to May 1999) (4) Richard R. Riegler 59 Senior Vice President - Engineering and Environmental Affairs (January 1999 to present); Senior Vice President - Operations, Philadelphia Suburban Water Company (April 1989 to January 1999) (5) Richard D. Hugus 56 President, Southern Operations (August 2003 to present); Vice President - Corporate Development, Pennsylvania Suburban Water Company (March 1991 to August 2003) (6) Karl M. Kyriss 55 President - Aqua Pennsylvania (March 2003 to present) (7) Robert G. Liptak, Jr. 58 President, Northern Operations (March 1999 to present); President, Consumers Pennsylvania Water Company (1980 to March 1999) (8) Robert A. Rubin 43 Vice President, Controller and Chief Accounting Officer (May 2005 to present); Controller and Chief Accounting Officer (March 2004 to May 2005); Controller (March 1999 to March 2004) (9) (1) In addition to the capacities indicated, the individuals named in the above table hold other offices or directorships with subsidiaries of the Registrant. Officers serve at the discretion of the Board of Directors. (2) Mr. DeBenedictis was Secretary of the Pennsylvania Department of Environmental Resources from 1983 to 1986. From December 1986 to April 1989, he was President of the Greater Philadelphia Chamber of Commerce. Mr. DeBenedictis was Senior Vice President for Corporate and Public Affairs of Philadelphia Electric Company from April 1989 to June 1992. (3) From January 1984 to August 1985, Mr. Stahl was Corporate Counsel, from August 1985 to May 1988 he was Vice President - Administration and Corporate Counsel of Aqua America, Inc., and from May 1988 to April 1991 he was Vice President and General Counsel of Aqua America, Inc.. (4) Mr. Smeltzer was Vice President - Controller of Philadelphia Suburban Water Company from March, 1986 to March 1991. 22
(5) Mr. Riegler was Chief Engineer of Philadelphia Suburban Water Company from 1982 to 1984. He then served as Vice President and Chief Engineer from 1984 to 1986 and Vice President of Operations from 1986 to 1989. (6) Mr. Hugus was Vice President and Treasurer of Philadelphia Suburban Water Company from December 1988 to March 1991. (7) Mr. Kyriss was Vice President - Northeast Region of American Water Works Services Company from 1997 to 2003. (8) Mr. Liptak was President of Consumers Pennsylvania Water Company from 1980 to March 1999. (9) Mr. Rubin was Accounting Manager with Aqua America, Inc. from June 1989 to June 1994. He then served from June 1994 to March 1999 as Assistant Controller of Philadelphia Suburban Water Company. Item 11. Executive Compensation The information appearing in the sections captioned "Executive Compensation" of the Proxy Statement relating to our May 17, 2006, annual meeting of shareholders, to be filed within 120 days after the end of the fiscal year covered by this Form 10-K Report, is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Ownership of Common Stock - The information appearing in the section captioned "Ownership of Common Stock" of the Proxy Statement relating to our May 17, 2006, annual meeting of shareholders, to be filed within 120 days after the end of the fiscal year covered by this Form 10-K Report, is incorporated herein by reference. Securities Authorized for Issuance under Equity Compensation Plans - The following table provides information for our equity compensation plan as of December 31, 2005: - --------------------------------------------------------------------------------------------------------------- Number of securities Number of securities remaining available for to be issued upon Weighted-average future issuance under exercise of exercise price of equity compensation plans outstanding options, outstanding options, (excluding securities Plan Category warrants and rights (a) warrants and rights (b) reflected in column (a)) - --------------------------------------------------------------------------------------------------------------- Equity compensation plans approved by security holders 3,492,363 $13.70 4,093,297 - --------------------------------------------------------------------------------------------------------------- Equity compensation plans not approved by security holders 0 0 0 - --------------------------------------------------------------------------------------------------------------- Total 3,492,363 $13.70 4,093,297 - --------------------------------------------------------------------------------------------------------------- Item 13. Certain Relationships and Related Transactions The information appearing in the sections captioned "Certain Relationships and Related Transactions" of the Proxy Statement relating to our May 17, 2006, annual meeting of shareholders, to be filed within 120 days after the end of the fiscal year covered by this Form 10-K Report, is incorporated herein by reference. 23
Item 14. Principal Accountant Fees and Services The information appearing in the section captioned "Independent Registered Public Accounting Firm - Services and Fees" of the Proxy Statement relating to our May 17, 2006, annual meeting of shareholders, to be filed within 120 days after the end of the fiscal year covered by this Form 10-K Report, is incorporated herein by reference. PART IV Item 15. Exhibits and Financial Statement Schedules Financial Statements. The following is a list of our consolidated financial statements and supplementary data incorporated by reference in Item 8 hereof: Management's Report on Internal Control Over Financial Reporting Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets - December 31, 2005 and 2004 Consolidated Statements of Income and Comprehensive Income - 2005, 2004 and 2003 Consolidated Cash Flow Statements - 2005, 2004 and 2003 Consolidated Statements of Capitalization - December 31, 2005 and 2004 Consolidated Statements of Common Stockholders' Equity - December 31, 2005, 2004 and 2003 Notes to Consolidated Financial Statements Financial Statement Schedules. All schedules to our consolidated financial statements are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or notes thereto. Exhibits, Including Those Incorporated by Reference. A list of exhibits filed as part of this annual report on Form 10-K is set forth in the Exhibit Index hereto which is incorporated herein by reference. Where so indicated by footnote, exhibits which were previously filed are incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated in parentheses. 24
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AQUA AMERICA, INC. By NICHOLAS DEBENEDICTIS ----------------------------------------------- Nicholas DeBenedictis Chairman, President and Chief Executive Officer Date: March 13, 2006 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Roy H. Stahl, Executive Vice President and General Counsel, and David P. Smeltzer, Senior Vice President -- Finance and Chief Financial Officer, as true and lawful attorneys-in-fact and agents with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities to sign this Report filed herewith and any or all amendments to said Report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission granting unto said attorneys-in-fact and agents the full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the foregoing, as to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or his or her substitute, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. 25
NICHOLAS DEBENEDICTIS DAVID P. SMELTZER - -------------------------------------------- ----------------------------------- Nicholas DeBenedictis David P. Smeltzer Chairman, President, Chief Executive Officer Senior Vice President - Finance and (principal executive officer) Chief Financial Officer and Director ROBERT A. RUBIN MARY C. CARROLL - -------------------------------------------- ----------------------------------- Robert A. Rubin Mary C. Carroll Principal Accounting Officer Director RICHARD H. GLANTON LON R. GREENBERG - -------------------------------------------- ----------------------------------- Richard H. Glanton Lon R. Greenberg Director Director WILLIAM P. HANKOWSKY JOHN F. MCCAUGHAN - -------------------------------------------- ----------------------------------- William P. Hankowsky John F. McCaughan Director Director JOHN E. MENARIO DR. CONSTANTINE PAPADAKIS - -------------------------------------------- ----------------------------------- John E. Menario Dr. Constantine Papadakis Director Director RICHARD L. SMOOT - -------------------------------------------- Richard L. Smoot Director 26
EXHIBIT INDEX Exhibit No. Description - ----------- ----------- 3.1 Restated Articles of Incorporation (as of December 9, 2004) (20) (Exhibit 3.1) 3.2 By-Laws, as amended (9) (Exhibit 3.2) 3.3 Amendment to Section 3.03 and addition of Section 3.17 to Bylaws (11) (Exhibits 1 and 2) 3.4 Amendment to Section 3.03 of the Bylaws (13) (Exhibit 3.8) 3.5 Amendments to Sections 2.01(a), 2.02 and 3.08(b) of the Bylaws (14) (Exhibit 3.10) 4.1 Indenture of Mortgage dated as of January 1, 1941 between Philadelphia Suburban Water Company and The Pennsylvania Company for Insurance on Lives and Granting Annuities(now First Pennsylvania Bank, N.A.), as Trustee, with supplements thereto through the Twentieth Supplemental Indenture dated as of August 1, 1983 (2) (Exhibits 4.1 through 4.16) 4.2 Agreement to furnish copies of other long-term debt instruments (1) (Exhibit 4.7) 4.3 Twenty-fourth Supplemental Indenture dated as of June 1, 1988 (3) (Exhibit 4.5) 4.4 Twenty-fifth Supplemental Indenture dated as of January 1, 1990 (4) (Exhibit 4.6) 4.5 Twenty-sixth Supplemental Indenture dated as of November 1, 1991 (5) (Exhibit 4.12) 4.6 Twenty-eighth Supplemental Indenture dated as of April 1, 1993 (6) (Exhibit 4.15) 4.7 Twenty-ninth Supplemental Indenture dated as of March 30, 1995 (7) (Exhibit 4.17) 4.8 Thirtieth Supplemental Indenture dated as of August 15, 1995 (8) (Exhibit 4.18) 4.9 Thirty-first Supplemental Indenture dated as of July 1, 1997 (10) (Exhibit 4.22) 4.10 First Amended and Restated Rights Agreement, dated as of February 20, 2004 between Aqua America, Inc. and Equiserve Trust Company, N.A., as Rights Agent. (22) (Exhibit 4.10) 4.11 Thirty-second Supplement Indenture, dated as of October 1, 1999 (12) (Exhibit 4.26) 4.12 Thirty-third Supplemental Indenture, dated as of November 15, 1999. (13) (Exhibit 4.27) 4.13 Revolving Credit Agreement between Philadelphia Suburban Water Company and PNC Bank National Association, First Union National Bank, N.A., Mellon Bank, N.A. dated as of December 22, 1999 (13) (Exhibit 4.27) 4.14 First Amendment to Revolving Credit Agreement dated as of November 28, 2000, between Philadelphia Suburban Water Company and PNC Bank, National Association, First Union National Bank, N.A., Mellon Bank, N.A. dated as of December 22, 1999 (14) (Exhibit 4.19) 4.15 Second Amendment to Revolving Credit Agreement dated as of December 18, 2001, between Philadelphia Suburban Water Company (and its successor Pennsylvania Suburban Water Company) and PNC Bank, National Association, Citizens Bank of Pennsylvania, First Union National Bank, N.A., Fleet National Bank dated as of December 22, 1999 (15) (Exhibit 4.20) 27
EXHIBIT INDEX Exhibit No. Description - ----------- ----------- 4.16 Thirty-fourth Supplemental Indenture, dated as of October 15, 2001. (15) (Exhibit 4.21) 4.17 Thirty-fifth Supplemental Indenture, dated as of January 1, 2002. (15) (Exhibit 4.22) 4.18 Thirty-sixth Supplemental Indenture, dated as of June 1, 2002. (17) (Exhibit 4.23) 4.19 Thirty-seventh Supplemental Indenture, dated as of December 15, 2002. (18) (Exhibit 4.23) 4.20 Credit Agreement dated as of October 25, 2002, between Philadelphia Suburban Corporation and PNC Bank, National Association. (18) (Exhibit 4.24) 4.21 Third Amendment to Revolving Credit Agreement dated as of December 16, 2002, between Philadelphia Suburban Water Company (and its successor Pennsylvania Suburban Water Company) and PNC Bank, National Association, Citizens Bank of Pennsylvania, Fleet National Bank dated as of December 22, 1999. (18) (Exhibit 4.25) 4.22 Fourth Amendment to Revolving Credit Agreement dated as of December 24, 2002, between Philadelphia Suburban Water Company (and its successor Pennsylvania Suburban Water Company) and PNC Bank, National Association, Citizens Bank of Pennsylvania, Fleet National Bank, National City Bank dated as of December 22, 1999. (18) (Exhibit 4.26) 4.23 Note Purchase Agreement among the note purchasers and Philadelphia Suburban Corporation, dated July 31, 2003 (19) (Exhibit 4.27) 4.24 Credit Agreement dated as of July 31, 2003, between Philadelphia Suburban Corporation and PNC Bank, National Association (19) (Exhibit 4.28) 4.25 Fifth Amendment to Revolving Credit Agreement dated as of December 14, 2003, between Philadelphia Suburban Water Company (and its successor Pennsylvania Suburban Water Company) and PNC Bank, National Association, Citizens Bank of Pennsylvania, Fleet National Bank, National City Bank dated as of December 22, 1999. (22) (Exhibit 4.25) 4.26 Credit Agreement dated as of May 28, 2004, between Aqua America, Inc. and PNC Bank, National Association (21) (Exhibit 4.26) 4.27 Sixth Amendment to Revolving Credit Agreement dated as of December 12, 2004 between Aqua Pennsylvania, Inc. (formerly known as Pennsylvania Suburban Water Company, successor by merger to Philadelphia Suburban Water Company) and PNC Bank, National Association, Citizens Bank of Pennsylvania, Fleet National Bank, National City Bank dated as of December 22, 1999. (25) (Exhibit 4.27) 4.28 Thirty-eighth Supplemental Indenture, dated as of November 15, 2004. (25) (Exhibit 4.28) 4.29 Thirty-ninth Supplemental Indenture, dated as of May 1, 2005. (24) (Exhibit 4.29) 4.30 Seventh Amendment to Revolving Credit Agreement dated as of December 6, 2005 between Aqua Pennsylvania, Inc. (formerly known as Pennsylvania Suburban Water Company, successor by merger to Philadelphia Suburban Water Company) and PNC Bank, National Association, Citizens Bank of Pennsylvania, Bank of America, N.A. (formerly Fleet National Bank), National City Bank dated as of December 22, 1999. 4.31 Fortieth Supplemental Indenture, dated as of December 15, 2005. 10.1 Excess Benefit Plan for Salaried Employees, effective December 1, 1989* (4) (Exhibit 10.4) 10.2 Supplemental Executive Retirement Plan, effective December 1, 1989* (4) (Exhibit 10.5) 10.3 Supplemental Executive Retirement Plan, effective March 15, 1992* (1) (Exhibit 10.6) 10.4 Employment letter agreement with Mr. Nicholas DeBenedictis, dated May 20, 1992* (1) (Exhibit 10.8) 28
EXHIBIT INDEX Exhibit No. Description - ----------- ----------- 10.5 1994 Equity Compensation Plan, as amended by Amendment effective August 5, 2003* (22) (Exhibit 10.5) 10.6 Placement Agency Agreement between Philadelphia Suburban Water Company and PaineWebber Incorporated dated as of March 30, 1995 (7) (Exhibit 10.12) 10.7 Bond Purchase Agreement among the Delaware County Industrial Development Authority, Philadelphia Suburban Water Company and Legg Mason Wood Walker, Incorporated dated August 24, 1995 (8) (Exhibit 10.13) 10.8 Construction and Financing Agreement between the Delaware County Industrial Development Authority and Philadelphia Suburban Water Company dated as of August 15, 1995 (8) (Exhibit 10.14) 10.9 Philadelphia Suburban Corporation Amended and Restated Executive Deferral Plan* (22) (Exhibit 10.9) 10.10 Philadelphia Suburban Corporation Deferred Compensation Plan Master Trust Agreement with PNC Bank, National Association, dated as of December 31, 1996* (9) (Exhibit 10.24) 10.11 First Amendment to Supplemental Executive Retirement Plan* (9) (Exhibit 10.25) 10.12 Placement Agency Agreement between Philadelphia Suburban Water Company and A.G. Edwards and Sons, Inc., Janney Montgomery Scott Inc., HSBC Securities, Inc., and PaineWebber Incorporated (10) (Exhibit 10.26) 10.13 The Director Deferral Plan* (22) (Exhibit 10.13) 10.14 Bond Purchase Agreement among the Delaware County Industrial Development Authority, Philadelphia Suburban Water Company and Commerce Capital Markets dated September 29, 1999 (12) (Exhibit 10.37) 10.15 Construction and Financing Agreement between the Delaware County Industrial Development Authority and Philadelphia Suburban Water Company dated as of October 1, 1999 (12) (Exhibit 10.38) 10.16 Placement Agency Agreement between Philadelphia Suburban Water Company and Merrill Lynch & Co., PaineWebber Incorporated, A.G. Edwards & Sons, Inc., First Union Securities, Inc., PNC Capital Markets, Inc. and Janney Montgomery Scott, Inc., dated as of November 15, 1999 (13) (Exhibit 10.41) 10.17 Bond Purchase Agreement among the Delaware County Industrial Development Authority, Philadelphia Suburban Water Company and The GMS Group, L.L.C., dated October 23, 2001 (15) (Exhibit 10.35) 10.18 Construction and Financing Agreement between the Delaware County Industrial Development Authority and Philadelphia Suburban Water Company dated as of October 15, 2001 (15) (Exhibit 10.36) 10.19 Agreement among Philadelphia Suburban Corporation, Philadelphia Suburban Water Company and Nicholas DeBenedictis, dated August 7, 2001* (15) (Exhibit 10.37) 29
EXHIBIT INDEX Exhibit No. Description - ----------- ----------- 10.20 Agreement among Philadelphia Suburban Corporation, Philadelphia Suburban Water Company and Roy H. Stahl, dated August 7, 2001* (15) (Exhibit 10.38) 10.21 Agreement among Philadelphia Suburban Corporation, Philadelphia Suburban Water Company and Richard R. Riegler, dated August 7, 2001* (15) (Exhibit 10.39) 10.22 Agreement among Philadelphia Suburban Corporation, Philadelphia Suburban Water Company and David P. Smeltzer, dated August 7, 2001* (15) (Exhibit 10.40) 10.23 Agreement among Philadelphia Suburban Corporation, Philadelphia Suburban Water Company and Richard D. Hugus, dated August 7, 2001* (22) (Exhibit 10.23) 10.24 2004 Annual Cash Incentive Compensation Plan* (22) (Exhibit 10.30) 10.25 Bond Purchase Agreement among the Bucks County Industrial Development Authority, Pennsylvania Suburban Water Company and Janney Montgomery Scott LLC, dated May 21, 2002 (17) (Exhibit 10.42) 10.26 Construction and Financing Agreement between the Bucks County Industrial Development Authority and Pennsylvania Suburban Water Company dated as of June 1, 2002 (17) (Exhibit 10.43) 10.27 Bond Purchase Agreement among the Delaware County Industrial Development Authority, Pennsylvania Suburban Water Company, and The GMS Group, L.L.C., dated December 19, 2002 (18) (Exhibit 10.44) 10.28 Construction and Financing Agreement between the Delaware County Industrial Development Authority and Pennsylvania Suburban Water Company dated as of December 15, 2002 (18) (Exhibit 10.45) 10.29 2005 Annual Cash Incentive Compensation Plan* (25) (Exhibit 10.29) 10.30 2006 Annual Cash Incentive Compensation Plan* 10.31 Bond Purchase Agreement among the Northumberland County Industrial Development Authority, Aqua Pennsylvania, Inc., and Sovereign Securities Corporation, LLC, dated November 16, 2004. (25) (Exhibit 10.31) 10.32 Aqua America, Inc. 2004 Equity Compensation Plan* (23) 10.33 2005 Executive Deferral Plan* (25) (Exhibit 10.33) 10.34 2005 Director Deferral Plan* (25) (Exhibit 10.34) 10.35 Non-Employee Directors' Compensation for 2006* (26) (Exhibit 10.1) 10.36 Bond Purchase Agreement among the Delaware County Industrial Development Authority, Aqua Pennsylvania, Inc. and Sovereign Securities Corporation, LLC, dated May 10, 2005. (24) (Exhibit 10.36) 10.37 Bond Purchase Agreement among the Delaware County Industrial Development Authority, Aqua Pennsylvania, Inc. and Sovereign Securities Corporation, LLC, dated December 21, 2005. 10.38 Aqua America, Inc. Dividend Reinvestment and Direct Stock Purchase Plan* (29) 10.39 Aqua America, Inc. Amended and Restated Employee Stock Purchase Plan* 10.40 Form of Stock Option Agreement* 10.41 2005 Salaries; Annual Incentive Compensation Earned in 2004* (27) (Exhibit 10.1) 30
EXHIBIT INDEX Exhibit No. Description - ----------- ----------- 10.42 Acceleration of Payout of 2003 and 2004 Dividend Equivalent Awards; Grants of 2005 Dividend Equivalent Awards; Performance Criteria for Acceleration of Payout of Dividend Equivalent Awards* (27) (Exhibit 10.2) 10.43 Vesting of Restricted Stock Granted in 2004; Grants of Restricted Stock* (27) (Exhibit 10.3) 10.44 2006 Salaries; Annual Incentive Compensation Earned in 2005* (28) (Exhibit 10.1) 10.45 Acceleration of Payout of 2004 and 2005 Dividend Equivalent Awards; Grants of 2006 Dividend Equivalent Awards; Performance Criteria for Acceleration of Payout of Dividend Equivalent Awards* (28) (Exhibit 10.2) 10.46 Vesting of Restricted Stock Granted in 2005; Grants of Restricted Stock* (28) (Exhibit 10.3) 13.1 Selected portions of Annual Report to Shareholders for the year ended December 31, 2005 incorporated by reference in Annual Report on Form 10-K for the year ended December 31, 2005. 21.1 Subsidiaries of Aqua America, Inc. 23.1 Consent of Independent Registered Public Accounting Firm - PricewaterhouseCoopers LLP 24.1 Power of Attorney (included on signature page) 31.1 Certification of Chief Executive Officer, pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934 31.2 Certification of Chief Financial Officer, pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934 32.1 Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350 32.2 Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350 31
Notes - Documents Incorporated by Reference (1) Filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 1992. (2) Indenture of Mortgage dated as of January 1, 1941 with supplements thereto through the Twentieth Supplemental Indenture dated as of August 1, 1983 were filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 1983. (3) Filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 1988. (4) Filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 1989. (5) Filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 1991. (6) Filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 1993. (7) Filed as an Exhibit to Quarterly Report on Form 10-Q for the quarter ended March 31, 1995. (8) Filed as an Exhibit to Quarterly Report on Form 10-Q for the quarter ended September 30, 1995. (9) Filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 1996. (10) Filed as an Exhibit to Quarterly Report on Form 10-Q for the quarter ended June 30, 1997. (11) Filed as an Exhibit to Form 8-K filed August 7, 1997. (12) Filed as an Exhibit to Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. (13) Filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 1999. (14) Filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 2000. (15) Filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 2001. (16) Filed as an Exhibit to Quarterly Report on Form 10-Q for the quarter ended March 31, 2002. (17) Filed as an Exhibit to Quarterly Report on Form 10-Q for the quarter ended June 30, 2002. (18) Filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 2002. (19) Filed as an Exhibit to Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 (20) Filed as an Exhibit to Form 8-K filed December 9, 2004. (21) Filed as an Exhibit to Quarterly Report on Form 10-Q for the quarter ended June 30, 2004. (22) Filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 2003. (23) Filed as Appendix C to definitive Proxy Statement dated April 2, 2004. (24) Filed as an Exhibit to Quarterly Report on Form 10-Q for the quarter ended June 30, 2005. (25) Filed as an Exhibit to Annual Report on Form 10-K for the year ended December 31, 2004. (26) Filed as an Exhibit to Form 8-K filed December 12, 2005. (27) Filed as an Exhibit to Form 8-K filed March 7, 2005. (28) Filed as an Exhibit to Form 8-K filed March 13, 2006. (29) Filed as a Registration Statement on Form S-3 on February 18, 2005. *Indicates management contract or compensatory plan or arrangement. 32
Exhibit 4.30 SEVENTH AMENDMENT TO CREDIT AGREEMENT THIS SEVENTH AMENDMENT TO CREDIT AGREEMENT is made as of this 6th day of December, 2005, by and among AQUA PENNSYLVANIA, INC., a Pennsylvania corporation (formerly known as Pennsylvania Suburban Water Company, successor by merger to Philadelphia Suburban Water Company) ("Borrower"), the several banks which are parties to this Agreement (each a "Bank" and collectively, "Banks") and PNC BANK, NATIONAL ASSOCIATION in its capacity as agent for Banks (in such capacity, "Agent"). BACKGROUND A. Borrower, Agent and Banks are parties to a Credit Agreement, dated as of December 22, 1999, as amended by a First Amendment to Credit Agreement dated as of November 28, 2000, a Second Amendment to Credit Agreement dated as of December 18, 2001, a Third Amendment to Credit Agreement dated as of December 16, 2002, a Fourth Amendment dated as of December 24, 2002, a Fifth Amendment to Credit Agreement dated as of December 14, 2003 and a Sixth Amendment to Credit Agreement dated as of December 12, 2004 (as so amended, the "Credit Agreement"), pursuant to which Banks agreed to make revolving credit loans to Borrower in an aggregate outstanding amount of up to $70,000,000 (the "Loans"). The Loans are evidenced by Borrower's Revolving Credit Notes in the aggregate principal face amount of $70,000,000. B. Borrower, Agent and Banks desire to extend the Termination Date of the facility, all on the terms and subject to the conditions herein set forth. NOW THEREFORE, the parties hereto, intending to be legally bound hereby, agree as follows: AGREEMENT 1. Terms. Capitalized terms used herein and not otherwise defined herein shall have the meanings given to such terms in the Credit Agreement. 2. Amendments to Credit Agreement. Effective on December 10, 2005 (the "Effective Date") the Credit Agreement is hereby amended as follows: (a) The definition of Termination Date in Section 1.1 is hereby amended and restated to read in full as follows: " "Termination Date": the earlier of (a) December 8, 2006 or any later date to which the Termination Date shall have been extended pursuant to subsection 2.8(d) hereof and (b) the date the Commitments are terminated as provided herein."
3. Loan Documents. Except where the context clearly requires otherwise, all references to the Credit Agreement in any of the Loan Documents or any other document delivered to Banks or Agent in connection therewith shall be to the Credit Agreement as amended by this Agreement. 4. Borrower's Ratification. Borrower agrees that it has no defenses or set-offs against Banks or Agent or their respective officers, directors, employees, agents or attorneys, with respect to the Loan Documents, all of which are in full force and effect, and that all of the terms and conditions of the Loan Documents not inconsistent herewith shall remain in full force and effect unless and until modified or amended in writing in accordance with their terms. Borrower hereby ratifies and confirms its obligations under the Loan Documents as amended hereby and agrees that the execution and delivery of this Agreement does not in any way diminish or invalidate any of its obligations thereunder. 5. Representations and Warranties. Borrower hereby represents and warrants to Agent and Banks that: (a) Except as otherwise previously disclosed to Agent and Banks, the representations and warranties made in the Credit Agreement, as amended by this Agreement, are true and correct as of the date hereof; (b) No Default or Event of Default under the Credit Agreement exists on the date hereof; and (c) This Agreement has been duly authorized, executed and delivered so as to constitute the legal, valid and binding obligations of Borrower, enforceable in accordance with its terms. All of the above representations and warranties shall survive the making of this Agreement. 6. Conditions Precedent. The effectiveness of the amendments set forth herein is subject to the fulfillment, to the satisfaction of Agent and its counsel, of the following conditions precedent on or before the Effective Date: (a) Borrower shall have delivered to Agent, with copies or counterparts for each Bank as appropriate, the following, all of which shall be in form and substance satisfactory to Agent and shall be duly completed and executed: (i) This Agreement; (ii) Copies, certified by the Secretary or an Assistant Secretary of Borrower as of a recent date, of resolutions of the board of directors of Borrower in effect on the date hereof authorizing the execution, delivery and performance of this Agreement and the other documents and transactions contemplated hereby;
(iii) Copies, certified by its corporate secretary as of a recent date, of the articles of incorporation, certificate of formation, and by-laws of Borrower as in effect, or a certificate stating that there have been no changes to any such documents since the most recent date, true and correct copies thereof were delivered to Agent; and (iv) Such additional documents, certificates and information as Agent or Banks may require pursuant to the terms hereof or otherwise reasonably request. (b) The representations and warranties set forth in the Credit Agreement shall be true and correct on and as of the date hereof. (c) No Default or Event of Default shall have occurred and be continuing as of the date hereof. (d) Borrower shall have paid to Agent for the benefit of Banks an extension fee of $84,000 to be distributed pro rata to Banks. 7. Miscellaneous. (a) All terms, conditions, provisions and covenants in the Loan Documents and all other documents delivered to Agent and Banks in connection therewith shall remain unaltered and in full force and effect except as modified or amended hereby. To the extent that any term or provision of this Agreement is or may be deemed expressly inconsistent with any term or provision in any Loan Document or any other document executed in connection therewith, the terms and provisions hereof shall control. (b) The execution, delivery and effectiveness of this Agreement shall neither operate as a waiver of any right, power or remedy of Agent or Banks under any of the Loan Documents nor constitute a waiver of any Default or Event of Default or default thereunder. (c) In consideration of Agent's and Banks' agreement to amend the existing credit facility, Borrower hereby waives and releases Agent and Banks and their respective officers, attorneys, agents and employees from any liability, suit, damage, claim, loss or expense of any kind or failure whatsoever and howsoever arising that it ever had up until, or has as of, the date of this Agreement. (d) This Agreement constitutes the entire agreement of the parties with respect to the subject matter hereof and supersedes all prior and contemporaneous understandings and agreements. (e) In the event any provisions of this Agreement shall be held invalid or unenforceable by any court of competent jurisdiction, such holding shall not invalidate or render unenforceable any other provision hereof.
(f) This Agreement shall be governed by and construed according to the laws of the Commonwealth of Pennsylvania. (g) This Agreement shall inure to the benefit of, and be binding upon, the parties hereto and their respective successors and assigns and may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. (h) The headings used in this Agreement are for convenience of reference only, do not form a part of this Agreement and shall not affect in any way the meaning or interpretation of this Agreement. IN WITNESS WHEREOF, Borrower, Agent and Banks have caused this Agreement to be executed by their duly authorized officers as of the date first above written. AQUA PENNSYLVANIA, INC. By: /s/ Kathy L. Pape ------------------------------------------------- Title: Vice President, Treasurer PNC BANK, NATIONAL ASSOCIATION, as a Bank and as Agent By: /s/ Forrest B. Patterson Jr. ------------------------------------------------- Title: Senior Vice President CITIZENS BANK OF PENNSYLVANIA By: /s/ Leslie Broderick ------------------------------------------------- Title: Senior Vice President BANK OF AMERICA, N.A. (formerly Fleet National Bank) By: /s/ Richard R. Powell ------------------------------------------------- Title: Vice President NATIONAL CITY BANK By: /s/ David P. Dobstaff ------------------------------------------------- Title: David P. Dobstaff, Senior Vice President
Prepared by and Return to: Exhibit 4.31 Mary T. Tomich, Esq. Dilworth Paxson LLP 1735 Market Street Philadelphia, PA 19103 215-575-7000 - -------------------------------------------------------------------------------- FORTIETH SUPPLEMENTAL INDENTURE DATED AS OF DECEMBER 15, 2005 TO INDENTURE OF MORTGAGE DATED AS OF JANUARY 1, 1941 __________ AQUA PENNSYLVANIA, INC. TO J.P. MORGAN TRUST COMPANY, NATIONAL ASSOCIATION __________
THIS FORTIETH SUPPLEMENTAL INDENTURE dated as of December 15, 2005, by and between AQUA PENNSYLVANIA, INC. (f/k/a Pennsylvania Suburban Water Company), a corporation duly organized and existing under the laws of the Commonwealth of Pennsylvania (the "Company") as successor by merger to the Philadelphia Suburban Water Company (the "Original Company"), party of the first part, and J.P. MORGAN TRUST COMPANY, NATIONAL ASSOCIATION, a national banking association (the "Trustee"), party of the second part. WHEREAS, the Original Company heretofore duly executed and delivered to The Pennsylvania Company for Insurances on Lives and Granting Annuities, as trustee, an Indenture of Mortgage dated as of January 1, 1941 (the "Original Indenture"), which by reference is hereby made a part hereof, and in and by the Original Indenture the Original Company conveyed and mortgaged to such trustee certain property therein described, to secure the payment of its bonds to be generally known as its "First Mortgage Bonds" and to be issued under the Original Indenture in one or more series as therein provided; and WHEREAS, through a series of mergers, changes of names and successions, J.P. Morgan Trust Company, National Association, became the successor trustee; such mergers, changes of name and successions not involving any change in the title, powers, rights or duties of the trustee, as trustee under the Original Indenture as supplemented at the respective dates thereof; and WHEREAS, the Original Company duly executed and delivered to the Trustee thirty-four supplemental indentures supplemental to the Original Indenture, and the Company duly executed and delivered to the Trustee five supplemental indentures to the Original Indenture so as to subject certain additional property to the lien of the Original Indenture and to provide for the creation of additional series of bonds; and WHEREAS, pursuant to an Agreement and Plan of Merger and Reorganization dated December 20, 2001, and effective on January 1, 2002, the Original Company agreed to merge, in conjunction with its affiliated corporations, Consumers Pennsylvania Water Company - Shenango Valley Division, Consumers Pennsylvania Water Company - Roaring Creek Division, Consumers Pennsylvania Water Company - Susquehanna Division, Waymart Water Company, Fawn Lake Forrest Water Company, Western Utilities, Inc., and Northeastern Utilities, Inc. (such affiliates referred to hereinafter as the "Merging Entities") with and into the Company; and WHEREAS, pursuant to the Thirty-Fifth Supplemental Indenture dated as of January 1, 2002 (the "Thirty-Fifth Supplemental Indenture"), the Company agreed to assume the obligations of the Original Company under the Original Indenture and all supplements thereto; and WHEREAS, the Company and its predecessor have issued under the Original Indenture, as supplemented at the respective dates of issue, forty-seven series of First Mortgage Bonds designated, respectively, as set forth in the following table, the Original or Supplemental Indenture creating each series and the principal amount of bonds thereof issued being indicated opposite the designation of such series: 1
DESIGNATION INDENTURE AMOUNT 3 1/4% Series due 1971 Original $16,375,000 9 5/8% Series due 1975 Thirteenth Supplemental 10,000,000 9.15% Series due 1977 Fourteenth Supplemental 10,000,000 3% Series due 1978 First Supplemental 2,000,000 3 3/8% Series due 1982 Second Supplemental 4,000,000 3.90% Series due 1983 Third Supplemental 5,000,000 3 1/2% Series due 1986 Fourth Supplemental 6,000,000 4 1/2% Series due 1987 Fifth Supplemental 4,000,000 4 1/8% Series due 1988 Sixth Supplemental 4,000,000 5% Series due 1989 Seventh Supplemental 4,000,000 4 5/8% Series due 1991 Eighth Supplemental 3,000,000 4.70% Series due 1992 Ninth Supplemental 3,000,000 6 7/8% Series due 1993 Twelfth Supplemental 4,500,000 4.55% Series due 1994 Tenth Supplemental 4,000,000 10 1/8% Series due 1995 Sixteenth Supplemental 10,000,000 5 1/2% Series due 1996 Eleventh Supplemental 4,000,000 7 7/8% Series due 1997 Fifteenth Supplemental 5,000,000 8.44% Series due 1997 Twenty-Third Supplemental 12,000,000 9.20% Series due 2001 Seventeenth Supplemental 7,000,000 8.40% Series due 2002 Eighteenth Supplemental 10,000,000 5.95% Series due 2002 Twenty-Seventh Supplemental 4,000,000 12.45% Series due 2003 Twentieth Supplemental 10,000,000 13% Series due 2005 Twenty-First Supplemental 8,000,000 10.65% Series due 2006 Twenty-Second Supplemental 10,000,000 9.89% Series due 2008 Twenty-Fourth Supplemental 5,000,000 7.15% Series due 2008 Twenty-Eighth Supplemental 22,000,000 9.12% Series due 2010 Twenty-Fifth Supplemental 20,000,000 8 7/8% Series due 2010 Nineteenth Supplemental 8,000,000 6.50% Series due 2010 Twenty-Seventh Supplemental 3,200,000 9.17% Series due 2011 Twenty-Sixth Supplemental 5,000,000 9.93% Series due 2013 Twenty-Fourth Supplemental 5,000,000 9.97% Series due 2018 Twenty-Fourth Supplemental 5,000,000 9.17% Series due 2021 Twenty-Sixth Supplemental 8,000,000 9.29% Series due 2026 Twenty-Sixth Supplemental 12,000,000 1995 Medium Term Note Twenty-Ninth Supplemental 77,000,000 Series 6.35% Series due 2025 Thirtieth Supplemental 22,000,000 1997 Medium Term Note Thirty-First Supplemental 65,000,000 Series 6.75% Subseries A due 2007 10,000,000 6.30% Subseries B due 2002 10,000,000 6.14% Subseries C due 2008 10,000,000 5.80% Subseries D due 2003 10,000,000 5.85% Subseries E due 2004 10,000,000 2
DESIGNATION INDENTURE AMOUNT 6.00% Subseries F due 2004 15,000,000 6.00% Series due 2029 Thirty-Second Supplemental $ 25,000,000 1999 Medium Term Note Thirty-Third Supplemental 222,334,480 Series 7.40% Subseries A due 2005 15,000,000 7.40% Subseries B due 2005 11,000,000 6.21% Subseries C due 2011 15,000,000 9.53% Subseries D due 2019 4,000,000 6.375% Subseries E due 2023 14,000,000 8.26% Subseries F due 2022 1,500,000 9.50% Subseries G due 2006 1,440,000 9.22% Subseries H due 2019 2,534,480 8.32% Subseries I due 2022 3,500,000 8.14% Subseries J due 2025 4,000,000 6.00% Subseries K due 2030 18,360,000 5.93% Subseries L due 2012 25,000,000 2.65% Subseries M due 2006 5,000,000 3.461% Subseries N due 2007 12,000,000 5.08% Subseries O due 2015 20,000,000 5.17% Subseries P due 2017 7,000,000 5.751% Subseries Q due 2019 15,000,000 5.751% Subseries R due 2019 5,000,000 6.06% Subseries S due 2027 15,000,000 6.06% Subseries T due 2027 5,000,000 5.98% Subseries U due 2028 3,000,000 5.35% Series due 2031 Thirty-Fourth Supplemental 30,000,000 5.55% Series due 2032 Thirty-Sixth Supplemental 25,000,000 3.75% Series due 2010 Thirty-Seventh Supplemental 3,200,000 5.15% Series due 2032 Thirty Seventh Supplemental 25,000,000 5.05% Series due 2039 Thirty-Eighth Supplemental 14,000,000 5.00% Series due 2036 Thirty-Ninth Supplemental 21,770,000 5.00% Series due 2037 Thirty-Ninth Supplemental 24,165,000 5.00% Series due 2038 Thirty-Ninth Supplemental 25,375,000 WHEREAS, the bonds of each of said series that are presently outstanding are listed on Exhibit A attached hereto and made a part hereof; and WHEREAS, the Original Indenture and the first thirty-nine supplemental indentures supplemental to the Original Indenture were duly recorded in the Commonwealth of Pennsylvania on the dates and in the office for the Recording of Deeds for the counties and in the Mortgage Books at the pages indicated in Exhibit B hereto; and WHEREAS, in order to secure the lien of the Original Indenture on the properties of the Original Company and the Company, the Original Indenture and the thirty-nine indentures supplemental thereto were recorded in the Commonwealth of Pennsylvania on the dates and in the office for the Recording of Deeds for the counties and in the Mortgage Books at the pages indicated on Exhibit B hereto; 3
WHEREAS, the lien of the Original Indenture, as supplemented, has been perfected as a security interest under the Pennsylvania Uniform Commercial Code by filing a financing statement in the office of the Secretary of the Commonwealth; and WHEREAS, the Company proposes to create under the Original Indenture, as supplemented by this Fortieth Supplemental Indenture, a series of bonds to be designated "First Mortgage Bonds, 5.00% Series due 2035" (herein referred to as the "5.00% Series due 2035") to be limited in aggregate principal amount to $24,675,000, to bear interest at the rate of 5.00% per annum, and to mature on February 1, 2035, to be issued only as registered bonds without coupons and to be dated the date of delivery thereof; and WHEREAS, in order to finance the costs of numerous acquisitions, constructions, modifications, expansions, installations and replacements of the Company's water distribution, treatment and related operating systems located in the Counties of Chester, Delaware and Montgomery in Pennsylvania and that are part of the Company's system for the distribution of water to its customers and related financing costs, which are to be financed under a Financing Agreement dated as of December 15, 2005 (the "Financing Agreement") between the Company and the Delaware County Industrial Development Authority, a Pennsylvania body politic and corporate (the "Authority"), and which are described in Exhibit A thereto (which facilities, less any deletions therefore and together with any additions, improvements and modifications thereto and substitutions therefore made in accordance with the provisions of the Financing Agreement are referred to as the "Facilities"), the Company has requested the Authority to issue a new series of bonds to be known as the Authority's Water Facilities Revenue Bonds (Aqua Pennsylvania, Inc. Project), Series C of 2005 in the aggregate principal amount of $24,675,000 (the "Authority Bonds"); and WHEREAS, the Company proposes to issue the Bonds under the provisions of Article IV of the Original Indenture, and will comply with the provisions thereof as well as with other provisions of the Original Indenture and indentures supplemental thereto in connection with the issuance of additional bonds so that it will be entitled to procure the authentication and delivery of the Bonds; and WHEREAS, the Authority Bonds are to be issued under a Trust Indenture, dated as of December 15, 2005 (the "Authority Indenture"), between the Authority and Wachovia Bank, National Association, as trustee (the "Authority Trustee"); and WHEREAS, the proceeds of the Authority Bonds are to be loaned to the Company pursuant to the terms of the Financing Agreement and the Bonds are to be issued by the Company to secure the obligation of the Company to pay to or for the account of the Authority an amount equal to the principal of, redemption premium, if any, and interest on the Authority Bonds pursuant to the Financing Agreement; and WHEREAS, the right, title and interest of the Authority in and to the Financing Agreement and the payments thereunder and the security for such payments are to be assigned by the Authority to the Authority Trustee, and the Bonds are to be delivered by the Company on behalf of the Authority directly to the Authority Trustee, as assignee of the Authority, as security for the payment of the principal of, redemption premium, if any, and interest on, the Authority Bonds; and 4
WHEREAS, Article XVIII of the Original Indenture provides that the Company, when authorized by resolution of its Board of Directors, may with the Trustee enter into an indenture supplemental to the Original Indenture, which thereafter shall form a part of the Original Indenture, for the purposes, inter alia, of subjecting to the lien of the Original Indenture additional property, of defining the covenants and provisions applicable to any bonds of any series other than the 3 1/4% Series due 1971, of adding to the covenants and agreements of the Company contained in the Original Indenture other covenants and agreements thereafter to be observed by the Company, of surrendering any right or power in the Original Indenture reserved to or conferred upon the Company, and of making such provisions in regard to matters or questions arising under the Original Indenture as may be necessary or desirable and not inconsistent therewith; and WHEREAS, the Company, by proper corporate action, has duly authorized the creation of the 5.00% Series due 2035 (to be issued in accordance with the terms and provisions of the Original Indenture and indentures supplemental thereto, including this Fortieth Supplemental Indenture, and to be secured by said Original Indenture and indentures supplemental thereto, including this Fortieth Supplemental Indenture) and has further duly authorized the execution, delivery and recording of this Fortieth Supplemental Indenture setting forth the terms and provisions of the 5.00% Series due 2035 insofar as said terms and provisions are not set forth in said Original Indenture; and WHEREAS, the Bonds and the Trustee's certificate upon said Bonds are to be substantially in the following form, the proper amount, names of registered owners and numbers to be inserted therein, and such appropriate insertions, omissions and changes to be made therein as may be required or permitted by this Indenture to conform to any pertinent law or usage: [Form of 5.00% Series due 2035] No. R-1 $24,675,000 AQUA PENNSYLVANIA, INC. (Incorporated under the Laws of the Commonwealth of Pennsylvania) First Mortgage Bond, 5.00% Series Due 2035 Aqua Pennsylvania, Inc. (f/k/a known as Pennsylvania Suburban Water Company, successor by merger to Philadelphia Suburban Water Company), a corporation organized and existing under the laws of the Commonwealth of Pennsylvania (hereinafter called the "Company", which term shall include any successor corporation as defined in the Indenture hereinafter referred to), for value received, hereby promises to pay to Delaware County Industrial Development Authority or its registered assigns, on the 1st day of February, 2035, at the designated office of J.P. Morgan Trust Company, National Association (hereinafter called the "Trustee") in Philadelphia, Pennsylvania, the sum of Twenty-Four Million Six Hundred Seventy-Five Thousand Dollars in such coin or currency of the United States of America as at the time of payment is legal tender for the payment of public and private debts and to pay interest thereon to the registered owner hereof by draft or check of the Trustee mailed to such registered owner from the interest payment date next preceding the date of the authentication of this Bond (or if this Bond is authenticated after a Record Date as defined below and on or before the succeeding interest payment date, from such succeeding interest payment date, or if this Bond is authenticated on or prior to January 15, 2006, from the date hereof) until the principal hereof shall become due and payable, at the rate of 5.00 percent (5.00%) per annum, payable semiannually in like coin or currency on the first day of February and the first day of August in each year, commencing February 1, 2006 and to pay interest on overdue principal (including any overdue required or optional prepayment of principal) and premium, if any, and, to the extent legally enforceable, on any overdue installment of interest at a rate of 5.00% per annum after maturity whether by acceleration or otherwise until paid. 5
The interest so payable will (except as otherwise provided in the Fortieth Supplemental Indenture referred to herein) be calculated on the basis of a 360-day year of twelve 30-day months and be paid to the person in whose name this Bond (or a Bond or Bonds in exchange for which this Bond was issued) is registered at the close of business on the fifteenth day of the calendar month next preceding the month in which the interest payment date occurs whether or not such day is a business day (a "Record Date") and principal, premium, if any, and interest on this Bond shall be paid in accordance with written payment instructions of the registered owner delivered to the Trustee on or before such record date. This Bond is one of a duly authorized issue of bonds of the Company known as its First Mortgage Bonds, issued and to be issued without limitation as to aggregate principal amount except as set forth in the Indenture hereinafter mentioned in one or more series and equally secured (except insofar as a sinking fund or other similar fund established in accordance with the provisions of the Indenture may afford additional security for the bonds of any specific series) by an Indenture of Mortgage (herein called the "Indenture") dated as of January 1, 1941, executed by the Philadelphia Suburban Water Company (now Aqua Pennsylvania, Inc., f/k/a Pennsylvania Suburban Water Company, as successor by merger) to The Pennsylvania Company for Insurances on Lives and Granting Annuities (succeeded as trustee by J.P. Morgan Trust Company, National Association), as Trustee (the "Trustee"), to which Indenture and all indentures supplemental thereto reference is hereby made for a description of the property mortgaged and pledged, the nature and extent of the security, the rights of the holders and registered owners of the bonds and of the Trustee in respect of such security, and the terms and conditions under which the bonds are and are to be secured and may be issued under the Indenture; but neither the foregoing reference to the Indenture nor any provision of this Bond or of the Indenture or of any indenture supplemental thereto shall affect or impair the obligation of the Company, which is absolute and unconditional, to pay at the stated or accelerated maturity herein and in the Indenture provided, the principal of and premium, if any, and interest on this Bond as herein provided. As provided in the Indenture, the bonds may be issued in series for various principal amounts, may bear different dates and mature at different times, may bear interest at different rates and may otherwise vary as in the Indenture provided or permitted. This Bond is one of the Bonds described in an indenture supplemental to said Indenture known as the "Fortieth Supplemental Indenture" dated as of December 15, 2005, and designated therein as "First Mortgage Bonds, 5.00% Series due 2035" (the "Bonds"). 6
To the extent permitted by and as provided in the Indenture, modifications or alterations of the Indenture, or of any indenture supplemental thereto, and of the rights and obligations of the Company and of the holders and registered owners of bonds issued and to be issued thereunder may be made with the consent of the Company by an affirmative vote of the holders and registered owners of not less than 75% in principal amount of bonds then outstanding under the Indenture and entitled to vote, at a meeting of the bondholders called and held as provided in the Indenture, and, in case one or more but less than all of the series of bonds then outstanding under the Indenture are so affected, by an affirmative vote of the holders and registered owners of not less than 75% in principal amount of bonds of any series then outstanding under the Indenture and entitled to vote on and affected by such modification or alteration, or by the written consent of the holders and registered owners of such percentages of bonds; provided, however, that no such modification or alteration shall be made which shall reduce the percentage of bonds the consent of the holders or registered owners of which is required for any such modification or alteration or which shall affect the terms of payment of the principal of or interest on the bonds, or permit the creation by the Company of any lien prior to or on a parity with the lien of the Indenture with respect to any property subject to the lien of the Indenture as a first mortgage lien thereon, or which shall affect the rights of the holders or registered owners of less than all of the bonds of any series affected thereby. The 2005 Bonds have been issued by the Company to secure the obligation of the Company to pay to or for the account of the Authority (defined below) an amount equal to the principal, premium, if any, of, and interest on, the Authority Bonds (defined below) pursuant to the Financing Agreement (the "Financing Agreement") dated as of December 15, 2005, between the Delaware County Industrial Development Authority, a Pennsylvania body politic and corporate (the "Authority"), and the Company, which Authority Bonds are being issued to finance the costs of numerous acquisitions, constructions, modifications, expansions, installations and replacements of the Company's water distribution, treatment and related operating systems located in the Counties of Chester, Delaware and Montgomery in Pennsylvania and that are part of the Company's system for the distribution of water to its customers and related financing costs which are to be financed under the Financing Agreement and which are described in Exhibit A thereto (which facilities, less any deletions therefrom and together with any additions, improvements and modifications thereto and substitutions therefor made in accordance with the provisions of the Financing Agreement are referred to as the "Facilities"). The Facilities are to be financed through the sale of the Authority's Water Facilities Revenue Bonds (Aqua Pennsylvania, Inc. Project), Series C of 2005, in the aggregate principal amount of $24,675,000 (the "Authority Bonds"). The Authority Bonds are to be issued under a Trust Indenture, dated as of December 15, 2005 (the "Authority Indenture") between the Authority and Wachovia Bank, National Association, as trustee (the "Authority Trustee"). The right, title and interest of the Authority in and to the Financing Agreement and the payments thereunder and the security for such payments have been assigned by the Authority to the Authority Trustee, and the Bonds have been delivered by the Company on behalf of the Authority directly to the Authority Trustee, as assignee, as security for the payment of the principal of, and premium, if any, and interest on, the Authority Bonds. The Authority Trustee may not sell, assign or otherwise transfer the Bonds except for a transfer of the entire outstanding principal amount thereof to its successor as trustee under the Authority Indenture, which successor and each subsequent successor shall hold such Authority Bonds subject to the same restriction on transfer. 7
In the event any Authority Bonds shall be purchased by the Company and cancelled pursuant to the Authority Indenture, Bonds corresponding in principal amount to the Authority Bonds so purchased and cancelled shall be deemed to be paid in full, and in the event and to the extent the principal of, and premium, if any, or interest on, any Authority Bonds is paid out of funds held by the Authority Trustee other than payments on Bonds, the corresponding payment of the principal of and premium, if any, or interest on, an aggregate principal amount of Bonds shall be deemed to have been satisfied. In the event this Bond shall be deemed to have been paid in full, this Bond shall be surrendered to the Trustee for cancellation. In the event this Bond shall be deemed to have been paid in part, this Bond shall be presented to the Trustee for notation hereon of the payment of the portion of the principal hereof so deemed to have been paid. The Bonds are redeemable only as follows: (a) The Bonds are subject to redemption prior to maturity, at the option of the Company, on or after February 1, 2015, in whole or in part, at a redemption price of 100% of the principal amount of the Bonds to be redeemed, plus interest accrued thereon to the date fixed for redemption. (b) The Bonds are also subject to redemption at the direction of the Company, in whole, at any time prior to maturity, at a redemption price of 100% of the principal amount of the bonds to be redeemed, plus interest accrued thereon to the date fixed for redemption, at any time the Authority Bonds are subject to extraordinary optional redemption pursuant to Section 7.01(a)(ii) of the Authority Indenture. (c) The Bonds are also subject to special mandatory redemption at the direction of the Company, in part, prior to maturity, at a redemption price of 100% of the principal amount of the bonds to be redeemed, plus interest accrued thereon to the date fixed for redemption, at such time and in such amount as the Authority Bonds are subject to special mandatory redemption pursuant to Section 7.01(a)(iii) of the Authority Indenture. (d) The Bonds are also subject to mandatory redemption by the Company in whole if the Trustee shall receive a written demand from the Authority Trustee for redemption of all such Bonds held by the Authority Trustee stating that an "Event of Default" as defined in Section 9.01(a) of the Authority Indenture has occurred and is continuing and that payment of the principal of the Authority Bonds has been accelerated pursuant to Section 9.01(b) of the Authority Indenture, provided that at the time of notice of such redemption as provided in Section 2 of Article V of the Original Indenture (i) said written demand shall not have been withdrawn by the Authority Trustee, and (ii) no event of default under Section 1 of Article XI of the Original Indenture shall have occurred and be continuing. 8
If this Bond or any portion hereof is called for redemption and payment thereof is duly provided for as specified in the Indenture, interest shall cease to accrue hereon or on such portion, as the case may be, from and after the date fixed for redemption. The principal hereof may be declared or may become due prior to its maturity date on the conditions, in the manner and with the effect set forth in the Indenture upon the happening of an event of default, as in the Indenture provided; subject, however, to the right, under certain circumstances, of the registered owners of a majority in principal amount of Bonds outstanding to annul such declaration. This Bond is transferable by the registered owner hereof in person or by attorney duly authorized in writing, on books of the Company to be kept for that purpose at the designated office of the Trustee in Philadelphia, Pennsylvania upon surrender hereof for cancellation at such office and upon presentation of a written instrument of transfer duly executed, and thereupon the Company shall issue in the name of the transferee or transferees, and the Trustee shall authenticate and deliver, a new Bond or Bonds in authorized denominations, of equal aggregate unpaid principal amount. Any such transfer or exchange shall be subject to the terms and conditions and to the payment of the charges specified in the Indenture. The Company and the Trustee may deem and treat the registered owner of this Bond as the absolute owner hereof for the purpose of receiving payment of or on account of the principal hereof and the interest hereon, and for all other purposes, and shall not be affected by any notice to the contrary. No recourse shall be had for the payment of the principal of or interest on this Bond or for any claim based hereon or otherwise in respect hereof or of the Indenture or of any indenture supplemental thereto against any incorporator or any past, present or future stockholder, officer or director of the Company or of any predecessor or successor corporation, as such, either directly or through the Company or through any such predecessor or successor corporation or through any receiver or trustee in bankruptcy, by virtue of any constitutional provision, statute or rule of law or equity, or by the enforcement of any assessment or penalty or otherwise; all such liability being, by the acceptance hereof and as part of the consideration for the issue hereof, expressly waived and released by every holder or registered owner hereof, as more fully provided in the Indenture. This Bond shall not be entitled to any benefit under the Indenture or any indenture supplemental thereto, or become valid or obligatory for any purpose, until J.P. Morgan Trust Company, National Association, as Trustee under the Indenture, or a successor trustee thereunder, shall have signed the certificate of authentication endorsed hereon. IN WITNESS WHEREOF, Aqua Pennsylvania, Inc. has caused this Bond to be signed by its President or a Vice President and its corporate seal to be hereto affixed and attested by its Secretary or an Assistant Secretary, and this Bond to be dated ________, 2005. Attest: AQUA PENNSYLVANIA, INC. By: (Assistant) Secretary Vice President and Treasurer 9
(Form of Trustee's Certificate) This Bond is one of the Bonds, of the series designated therein, referred to in the within-mentioned Fortieth Supplemental Indenture. J.P. MORGAN TRUST COMPANY, NATIONAL ASSOCIATION By:__________________________ Authorized Signer and; WHEREAS, all acts and things necessary to make the Bonds, when executed by the Company and authenticated and delivered by the Trustee as in this Fortieth Supplemental Indenture provided and issued by the Company, valid, binding and legal obligations of the Company, and this Fortieth Supplemental Indenture a valid and enforceable supplement to said Original Indenture, have been done, performed and fulfilled, and the execution of this Fortieth Supplemental Indenture has been in all respects duly authorized; and NOW, THEREFORE, THIS FORTIETH SUPPLEMENTAL INDENTURE WITNESSETH: That, in order to secure the payment of the principal and interest of all bonds issued under the Original Indenture and all indentures supplemental thereto, according to their tenor and effect, and according to the terms of the Original Indenture and of any indenture supplemental thereto, and to secure the performance of the covenants and obligations in said bonds and in the Original Indenture and any indenture supplemental thereto respectively contained, and to provide for the proper issuing, conveying and confirming unto the Trustee, its successors in said trust and its and their assigns forever, upon the trusts and for the purposes expressed in the Original Indenture and in any indenture supplemental thereto, all and singular the estates, property and franchises of the Company thereby mortgaged or intended so to be, the Company, for and in consideration of the premises and of the sum of One Dollar ($1.00) in hand paid by the Trustee to the Company upon the execution and delivery of this Fortieth Supplemental Indenture, receipt whereof is hereby acknowledged, and of other good and valuable consideration, and intending to be legally bound, has granted, bargained, sold, aliened, enfeoffed, released and confirmed and by these presents does grant, bargain, sell, alien, enfeoff, release and confirm unto J.P. Morgan Trust Company, National Association, as Trustee, and to its successors in said trust and its and their assigns forever: All and singular the premises, property, assets, rights and franchises of the Company, whether now or hereafter owned, constructed or acquired, of whatever character and wherever situated (except as herein expressly excepted), including among other things the following, but reference to or enumeration of any particular kinds, classes, or items of property shall not be deemed to exclude from the operation and effect of the Original Indenture or any indenture supplemental thereto any kind, class or item not so referred to or enumerated: 10
I. REAL ESTATE AND WATER RIGHTS. The real estate described in the deeds from the grantors named in Exhibit C hereto, dated and recorded as therein set forth, and any other real estate and water rights acquired since the date of the Thirty-Ninth Supplemental Indenture. II. BUILDINGS AND EQUIPMENT. All mains, pipes, pipe lines, service pipes, buildings, improvements, standpipes, reservoirs, wells, flumes, sluices, canals, basins, cribs, machinery, conduits, hydrants, water works, plants and systems, tanks, shops, structures, purification systems, pumping stations, fixtures, engines, boilers, pumps, meters and equipment which are now owned or may hereafter be acquired by the Company (except as herein expressly excepted), including all improvements, additions and extensions appurtenant to any real or fixed property now or hereafter subject to the lien of the Original Indenture or any indenture supplemental thereto which are used or useful in connection with the business of the Company as a water company or as a water utility, whether any of the foregoing property is now owned or may hereafter be acquired by the Company. It is hereby declared by the Company that all property of the kinds described in the next preceding paragraph, whether now owned or hereafter acquired, has been or is or will be owned or acquired with the intention of using the same in carrying on the business or branches of the business of the Company, and it is hereby declared that it is the intention of the Company that all thereof (except property hereinafter specifically excepted) shall be subject to the lien of the Original Indenture. It is agreed by the Company that so far as may be permitted by law, tangible personal property now owned or hereafter acquired by the Company, except such as is hereafter expressly excepted from the lien hereof, shall be deemed to be and construed as fixtures and appurtenances to the real property of the Company. III. FRANCHISES AND RIGHTS OF WAY. All the corporate and other franchises of the Company, all water and flowage rights, riparian rights, easements and rights of way, and all permits, licenses, rights, grants, privileges and immunities, and all renewals, extensions, additions or modifications of any of the foregoing, whether the same or any thereof, or any renewals, extensions, additions or modifications thereof, are now owned or may hereafter be acquired, owned, held, or enjoyed by the Company. 11
IV. AFTER ACQUIRED PROPERTY. All real and fixed property and all other property of the character hereinabove described which the Company may hereafter acquire. TOGETHER WITH all and singular the tenements, hereditaments and appurtenances belonging or in any way appertaining to the aforesaid property or any part thereof, with the reversion and reversions, remainder and remainders, tolls, rents, revenues, issues, income, product and profits thereof, and all the estate, right, title, interest and claim whatsoever, at law as well as in equity, which the Company now has or may hereafter acquire in and to the aforesaid premises, property, rights and franchises and every part and parcel thereof. EXCEPTING AND RESERVING, HOWEVER, certain premises, not used or useful in the supplying of water by the Company, expressly excepted and reserved from the lien of the Original Indenture and not subject to the terms thereof. AND ALSO SAVING AND EXCEPTING from the property hereby mortgaged and pledged, all of the following property (whether now owned by the Company or hereafter acquired by it): All bills, notes and accounts receivable, cash on hand and in banks, contracts, choses in action and leases to others (as distinct from the property leased and without limiting any rights of the Trustee with respect thereto under any of the provisions of the Original Indenture or of any indenture supplemental thereto), all bonds, obligations, evidences of indebtedness, shares of stock and other securities, and certificates or evidences of interest therein, all automobiles, motor trucks, and other like automobile equipment and all furniture, and all equipment, materials, goods, merchandise and supplies acquired for the purpose of sale in the ordinary course of business or for consumption in the operation of any properties of the Company other than any of the foregoing which may be specifically transferred or assigned to or pledged or deposited with the Trustee hereunder or required by the provisions of the Original Indenture or any indenture supplemental thereto so to be; provided, however, that if, upon the happening of a completed default, as specified in Section 1 of Article XI of the Original Indenture, the Trustee or any receiver appointed hereunder shall enter upon and take possession of the mortgaged property, the Trustee or any such receiver may, to the extent permitted by law, at the same time likewise take possession of any and all of the property described in this paragraph then on hand and any and all other property of the Company then on hand, not described or referred to in the foregoing granting clauses, which is used or useful in connection with the business of the Company as a water company or as a water utility, and use and administer the same to the same extent as if such property were part of the mortgaged property, unless and until such completed default shall be remedied or waived and possession of the mortgaged property restored to the Company, its successors or assigns. SUBJECT, HOWEVER, to the exceptions, reservations and matters hereinabove and in the Original Indenture recited, to releases executed since the date of the Original Indenture in accordance with the provisions thereof, to existing leases, to easements and rights of way for pole lines and electric transmission lines and other similar encumbrances and restrictions which the Company hereby certifies, in its judgment, do not impair the use of said property by the Company in its business, to liens existing on or claims against, and rights in and relating to, real estate acquired for right-of-way purposes, to taxes and assessments not delinquent, to alleys, streets and highways that may run across or encroach upon said lands, to liens, if any, incidental to construction, and to Permitted Liens, as defined in the Original Indenture; and, with respect to any property which the Company may hereafter acquire, to all terms, conditions, agreements, covenants, exceptions and reservations expressed or provided in such deeds and other instruments, respectively, under and by virtue of which the Company shall hereafter acquire the same and to any and all liens existing thereon at the time of such acquisition. 12
TO HAVE AND TO HOLD, all and singular the property, rights, privileges and franchises hereby conveyed, transferred or pledged or intended so to be unto the Trustee and its successors in the trust heretofore and hereby created, and its and their assigns forever. IN TRUST NEVERTHELESS, for the equal pro rata benefit and security of each and every entity who may be or become the holders of bonds and coupons secured by the Original Indenture or by any indenture supplemental thereto, or both, without preference, priority or distinction as to lien or otherwise of any bond or coupon over or from any other bond or coupon, so that each and every of said bonds and coupons issued or to be issued, of whatsoever series, shall have the same right, lien and privilege under the Original Indenture and all indentures supplemental thereto and shall be equally secured hereby and thereby, with the same effect as if said bonds and coupons had all been made, issued and negotiated simultaneously on the date thereof; subject, however, to the provisions with reference to extended, transferred or pledged coupons and claims for interest contained in the Original Indenture and subject to any sinking or improvement fund or maintenance deposit provisions, or both, for the benefit of any particular series of bonds. IT IS HEREBY COVENANTED, DECLARED AND AGREED, by and between the parties hereto, that all such bonds and coupons are to be authenticated, delivered and issued, and that all property subject or to become subject hereto is to be held subject to the further covenants, conditions, uses and trusts hereinafter set forth, and the Company, for itself and its successors and assigns, does hereby covenant and agree to and with the Trustee and its successor or successors in said trust, for the benefit of those who shall hold said bonds and coupons, or any of them, issued under this Indenture or any indenture supplemental hereto, or both, as follows: ARTICLE I. Form, Authentication and Delivery of the Bonds; Redemption Provisions SECTION 1. There shall be a forty-eighth series of bonds, limited in aggregate principal amount to $24,675,000 designated as "Aqua Pennsylvania, Inc., First Mortgage Bonds, 5.00% Series due 2035". Interest on the Bonds shall be payable semiannually on February 1 and August 1 of each year (each an "interest payment date"), commencing February 1, 2006. Each Bond shall be dated the date of its authentication and shall bear interest from the interest payment date next preceding the date of the authentication of such Bond (or if such Bond is authenticated after a Record Date as defined below and on or before the succeeding interest payment date, from such succeeding interest payment date, or if such Bond is authenticated on or prior to the record date for the first interest payment date for the Bonds, in which case it shall bear interest from the date of original issuance of the Bonds); provided, however, that, if at the time of authentication of any Bond, interest on the predecessor Bond of such Bond is in default, such Bond shall bear interest from the date to which interest has been paid, or, if no interest has been paid, from the date of original issuance thereof. The 5.00% Series due 2035 shall be stated to mature (subject to the right of earlier redemption at the prices and dates and upon the terms and conditions hereinafter set forth) on February 1, 2035 and shall bear interest at the rate of 5.00%. 13
The 5.00% Series due 2035 shall be issuable only as registered bonds without coupons, shall be in the form hereinabove recited, in the denomination of Five Thousand Dollars ($5,000) or any integral multiple thereof, shall be lettered "R-1" and shall bear such numbers as the Company may reasonably require. The principal of, and interest on the Bonds shall be payable at the designated office of the trustee in Philadelphia, Pennsylvania, and shall be payable, along with interest on the Bonds, in such coin or currency of the United States of America as at the time of payment is legal tender for the payment of public and private debts; each installment of interest shall be paid by check to the order of the person entitled thereto, mailed to such person's address as the same appears on the books maintained for such purpose by or on behalf of the Company, or by bank wire transfer of immediately available funds pursuant to instructions and conditions incorporated in an agreement between such person and the Trustee or the Company. The person in whose name any Bond is registered at the close of business on any Record Date (as hereinafter defined) with respect to any interest payment date shall be entitled to receive the interest payable on such interest payment date notwithstanding the cancellation of such Bond upon any transfer or exchange subsequent to the Record Date and prior to such interest payment date; provided, however, that if and to the extent the Company shall default in the payment of the interest due on such interest payment date, such defaulted interest shall be paid to the persons in whose names outstanding Bonds are registered at the close of business on a subsequent Record Date established by notice given by mail by or on behalf of the Company to the holders of Bonds not less than fifteen days preceding such subsequent Record Date, such Record Date to be not less than ten days preceding the date of payment of such defaulted interest. The term "Record Date" with respect to any regular interest payment date shall mean the fifteenth day of the calendar month next preceding the month in which such interest payment date occurs. The Bonds are being issued by the Company to secure the obligation of the Company to pay to or for the account of the Authority an amount equal to the principal of, at maturity or earlier redemption, and interest on, the Authority Bonds pursuant to the Financing Agreement. The Authority Bonds are being sold to finance the Facilities. The Authority Bonds are to be issued under the Authority Indenture and the right, title and interest of the Authority in and to the Financing Agreement and the payments thereunder and the security for such payments have been assigned by the Authority to the Authority Trustee, and the Bonds are to be delivered by the Company on behalf of the Authority directly to the Authority Trustee, as assignee, as security for the payment of the principal of, at maturity or earlier redemption, and premium, if any, and interest on, the Authority Bonds. The Authority Trustee may not sell, assign or otherwise transfer the Bonds except for a transfer of the entire outstanding principal amount thereof to its successor as Trustee under the Authority Indenture, which successor and each subsequent successor shall hold the Bonds subject to the same restriction on transfer. 14
The text of the Bonds and of the certificate of the Trustee upon such Bonds shall be, respectively, substantially of the tenor and effect hereinbefore recited. Exchange of any Bonds shall be effected in accordance with the applicable provisions of Sections 7, 8 and 9 of Article II of the Original Indenture. SECTION 2. The Bonds are redeemable only as follows: (a) The 5.00% Series due 2035 are subject to redemption prior to maturity on or after February 1, 2015 by the Company, to the extent that the Authority Bonds are called for redemption under Section 7.01(a)(i) of the Authority Indenture, and then out of moneys deposited with or held by the Trustee for such purpose, as a whole or in part, at any time in the manner described below, at the redemption price of one hundred percent (100%) of the principal amount to be redeemed, plus interest accrued thereon to the date fixed for redemption; (b) The 5.00% Series due 2035 are subject to redemption at the direction of the Company, in whole, at any time prior to maturity, at a redemption price of 100% of the principal amount to be redeemed, plus interest accrued thereon to the date fixed for redemption, at any time the Authority Bonds maturing February 1, 2035 are subject to extraordinary optional redemption pursuant to Section 7.01(a)(ii) of the Authority Indenture; (c) The 5.00% Series due 2035 are also subject to special mandatory redemption at the direction of the Company, in part, prior to maturity, at a redemption price of 100% of the principal amount of the bonds to be redeemed, plus interest accrued thereon to the date fixed for redemption, at such time and in such amount as the Authority Bonds maturing February 1, 2035 are subject to special mandatory redemption pursuant to Section 7.01(a)(iii) of the Authority Indenture. (d) The 5.00% Series due 2035 are also subject to mandatory redemption by the Company in whole if the Trustee shall receive a written demand from the Authority Trustee for redemption of all such Bonds held by the Authority Trustee stating that an "Event of Default" as defined in Section 9.01(a) of the Authority Indenture has occurred and is continuing and that payment of the principal of the Authority Bonds has been accelerated pursuant to Section 9.01(b) of the Authority Indenture, provided that at the time of notice of such redemption as provided in Section 2 of Article V of the Original Indenture (i) said written demand shall not have been withdrawn by the Authority Trustee, and (ii) no event of default under Section 1 of Article XI of the Original Indenture shall have occurred and be continuing. SECTION 3. Any redemption of the Bonds shall be effected in accordance with the provisions of Article V of the Original Indenture. SECTION 4. In the event any Authority Bonds shall be purchased by the Company, surrendered by the Company to the Authority Trustee for cancellation and cancelled by the Authority Trustee, Bonds corresponding in principal amount to the Authority Bonds so purchased, surrendered and cancelled shall be deemed to have been paid in full. 15
SECTION 5. In the event and to the extent the principal of and premium, if any, or interest on, any Authority Bonds is paid out of funds held by the Authority Trustee other than payments of Bonds, the corresponding payment of the principal of, and premium, if any, or interest on, an aggregate principal amount of Bonds equal to the aggregate principal amount of such Authority Bonds shall be deemed to have been satisfied. SECTION 6. All Bonds deemed to have been paid in full as provided in Section 4 and 5 of this Article I of this Fortieth Supplemental Indenture shall be surrendered to the Trustee for cancellation, and the Trustee shall forthwith cancel the same and, in accordance with applicable laws and regulations and the Trustee's policies and procedures, and on the written request of the Company, deliver the same to the Company. In case part of an outstanding Bond shall be deemed to have been partially paid as provided in said Section 4 or Section 5, upon presentation of such Bond at the designated office of the Trustee, the Trustee shall make a notation thereon of the payment of the portion of the principal amount of such Bond so deemed to have been paid unless the registered owner shall elect to surrender such Bond to the Trustee, in which case the Company shall execute and the Trustee shall authenticate and deliver, without charge to the registered owner, Bonds in such authorized denominations as shall be specified by the registered owner for the unpaid balance of the principal amount of such outstanding Bond. SECTION 7. The 5.00% Series due 2035 in the aggregate principal amount of $24,675,000 may be issued under the provisions of Article IV of the Original Indenture and may forthwith be executed by the Company and delivered to the Trustee and shall be authenticated by the Trustee and delivered to or upon the order of the Company, upon receipt by the Trustee of the resolutions, certificates, opinions or other instruments or all of the foregoing required to be delivered upon the issue of bonds pursuant to the provisions of the Original Indenture. ARTICLE II. Maintenance or Improvement Deposit. SECTION 1. The Company covenants that it will deposit with the Trustee on or before the March 1 next occurring after the bonds of the 9.89% Series due 2008 cease to be outstanding, or on or before the March 1 next occurring after the bonds of the 9.93% Series due 2013 cease to be outstanding, or on or before the next March 1 next occurring after the bonds of the 9.97% Series due 2018 cease to be outstanding, or on or before the March 1 next occurring after the bonds of the 9.12% Series due 2010 cease to be outstanding, or on or before the March 1 next occurring after the bonds of the 9.29% Series due 2026 cease to be outstanding, or on or before the March 1 next occurring after the bonds of the 9.17% Series due 2021 cease to be outstanding, or on or before the next March 1 next occurring after the bonds of the 9.17% Series due 2011 cease to be outstanding, or on or before the March 1 next occurring after the bonds of the 7.15% Series due 2008 cease to be outstanding, or on or before the March 1 next occurring after the bonds of any of the Subseries of the 1995 Medium Term Note Series issued under the Twenty-Ninth Supplemental Indenture (consisting of the 7.72% Subseries A due 2025, the 6.89% Subseries C due 2015, and the 6.99% Subseries D due 2006) shall cease to be outstanding, or on or before the March 1 next occurring after the bonds of any of the Subseries of 16
the 1997 Medium Term Note Series issued under the Thirty-First Supplemental Indenture (consisting of the 6.75% Subseries A due 2007 and the 6.14% Subseries C due 2008) cease to be outstanding, or on or before March 1 next occurring after the bonds of 6.00% Series due 2029 cease to be outstanding, or on or before March 1 next occurring after the bonds of any of the Subseries of the 1999 Medium Term Note Series issued under the Thirty-Third Supplemental Indenture (consisting of the 9.53% Subseries D due 2019, the 8.26% Subseries F due 2022, the 9.50% Subseries G due 2006, the 9.22% Subseries H due 2019, the 8.32% Subseries I due 2022, the 8.14% Subseries J due 2025, the 6.00% Subseries K due 2030, the 5.93% Subseries L due 2012, the 2.65% Subseries M due 2006, the 3.461% Subseries N due 2007, the 5.08% Subseries O due 2015, the 5.17% Subseries P due 2017, the 5.751% Subseries Q due 2019, the 5.751% Subseries R due 2019, the 6.06% Subseries S due 2027, the 6.06% Subseries T due 2027 and the 5.98% Subseries U due 2028) cease to be outstanding, or on or before March 1 next occurring after the bonds of the 5.35% Series due 2031 cease to be outstanding, or on or before March 1 next occurring after the bonds of the 5.55% Series due 2032 cease to be outstanding, or on or before March 1 next occurring after the bonds of the 3.75% Series due 2010 cease to be outstanding, or on or before March 1 next occurring after the bonds of the 5.15% Series due 2032 cease to be outstanding, or on or before March 1 next occurring after the bonds of the 5.05% Series due 2039 cease to be outstanding, or on or before March 1 next occurring after the bonds of the 5.00% Series due 2036 cease to be outstanding, or on or before March 1 next occurring after the bonds of the 5.00% Series due 2037 cease to be outstanding, or on or before March 1 next occurring after the bonds of the 5.00% Series due 2038 cease to be outstanding, whichever is latest, an amount in cash (the "Maintenance or Improvement Deposit") equal to 9% of the Gross Operating Revenues of the Company during the preceding calendar year less, to the extent that the Company desires to take such credits, the following: (a) the amount actually expended for maintenance during such calendar year; and (b) the Cost or Fair Value, whichever is less, of Permanent Additions acquired during such calendar year which at the time of taking such credit constitute Available Permanent Additions; and (c) the unapplied balance, or any part thereof, of the Cost or Fair Value, whichever is less, of Available Permanent Additions acquired by the Company during the five calendar years preceding such calendar year and specified in the Officers' Certificates delivered to the Trustee pursuant to Section 2 of this Article, but only to the extent that the Permanent Additions with respect to which such Cost or Fair Value was determined shall at the time of taking such credit constitute Available Permanent Additions. SECTION 2. The Company covenants that it will on or before March 1 in each year, beginning with the first deposit made with the Trustee under the provisions of Section 1 of this Article, as long as any of the Bonds are outstanding, deliver to the Trustee the following: (a) An Officers' Certificate, which shall state: (i) The amount of the Gross Operating Revenues for the preceding calendar year; 17
(ii) 9% of such Gross Operating Revenues; (iii) The amount actually expended by the Company for maintenance during such calendar year; (iv) The amount set forth in subparagraph (xii) of each Officers' Certificate delivered to the Trustee pursuant to the provisions of this Section during the preceding five calendar years (specifying each such Officers' Certificate), after deducting from each such amount the aggregate of (a) the Cost or Fair Value, whichever is less, of all Permanent Additions represented by such amount which have ceased to be Available Permanent Additions; and (b) any part of such amount for which the Company has previously taken credit against any Maintenance or Improvement Deposit (specifying the Officers' Certificate in which such credit was taken); and (c) any part of such amount for which the Company then desires to take credit against the Maintenance or Improvement Deposit; (v) An amount which shall be the aggregate of all amounts set forth pursuant to the provisions of clause (c) of the foregoing subparagraph (iv); (vi) The Cost or Fair Value, whichever is less, of Available Permanent Additions acquired by the Company during the preceding calendar year; (vii) That part of the amount set forth in subparagraph (vi) which the Company desires to use as a credit against the Maintenance or Improvement Deposit; (viii) The amount of cash payable to the Trustee under the provisions of Section 1 of this Article, which shall be the amount by which the amount set forth in subparagraph (ii) hereof exceeds the sum of the amounts set forth in subparagraphs (iii), (v) and (vii) hereof; (ix) The sum of all amounts charged on the books of the Company against any reserve for retirement or depreciation during the preceding calendar year representing the aggregate of the Cost when acquired of any part of the Company's plants and property of the character described in the granting clauses hereof which has been permanently retired or abandoned; (x) The aggregate of the amounts set forth in subparagraphs (v) and (vii) hereof; (xi) The amount by which the amount set forth in subparagraph (x) exceeds the amount set forth in subparagraph (ix), being the amount required to be deducted from the Cost or Fair Value of Available Permanent Additions in order to determine a Net Amount of Available Permanent Additions pursuant to the provisions of Section 9 of Article I of the Original Indenture; (xii) The amount set forth in subparagraph (vi) after deducting the amount, if any, set forth in subparagraph (vii); and 18
(xiii) That all conditions precedent to the taking of the credit or credits so requested by the Company have been complied with. (b) In the event that the Officers' Certificate delivered to the Trustee pursuant to the provisions of paragraph (a) of this Section shall state, pursuant to the requirements of subparagraph (vi), the Cost or Fair Value of Available Permanent Additions acquired by the Company during the preceding calendar year, the documents specified in paragraphs 2, 3, 5, 6 and 7 of subdivision (B) of Section 3 of Article IV of the Original Indenture. (c) An amount in cash equal to the sum set forth in subparagraph (viii) of the Officers' Certificate provided for in paragraph (a) hereof. SECTION 3. All cash deposited with the Trustee as part of any Maintenance or Improvement Deposit provided for in Section 1 of this Article, may, at the option of the Company, be applied to the purchase of bonds under the provisions of Section 2 of Article X of the Original Indenture or to the redemption of bonds under the provisions of Section 3 of Article X of the Original Indenture or may be withdrawn by the Company at any time to reimburse the Company for the cost of a Net Amount of Available Permanent Additions (excluding, however, from any such Available Permanent Additions all Permanent Additions included in any certificate delivered to the Trustee for the purpose of obtaining a credit against any Maintenance or Improvement Deposit provided for in Section 1 of this Article to the extent that such Permanent Additions have been used for any such credit). The Trustee shall pay to or upon the written order of the Company all or any part of such cash upon the receipt by the Trustee of: (a) A Resolution requesting such payment; and (b) The documents specified in paragraphs 2, 5, 6 and 7 of subdivision (B) of Section 3 of Article IV of the Original Indenture, with such modifications, additions and omissions as may be appropriate in the light of the purposes for which they are used. ARTICLE III. Covenants of the Company. SECTION 1. The Company hereby covenants and agrees with the Trustee, for the benefit of the Trustee and all the present and future holders of the Bonds, that the Company will pay the principal of, and premium, if any, and interest on, all bonds issued or to be issued as aforesaid under and secured by the Original Indenture as hereby supplemented, as well as all bonds which may be hereafter issued in exchange or substitution therefor, and will perform and fulfill all of the terms, covenants and conditions of the Original Indenture and of this Fortieth Supplemental Indenture with respect to the additional bonds to be issued under the Original Indenture as hereby supplemented. SECTION 2. The Company covenants and agrees that so long as any of the Bonds are outstanding (a) the Company will not make any Stock Payment if, after giving effect thereto, its retained earnings, computed in accordance with generally accepted accounting principles consistently applied, will be less than the sum of (i) Excluded Earnings, if any, since December 31, 2004, and (ii) $20,000,000; (b) Stock Payments made more than 40 days after the commencement, and prior to the expiration, of any Restricted Period shall not exceed 65% of the Company's Net Income during such Restricted Period; and (c) the Company will not authorize a Stock Payment if there has occurred and is continuing an event of default under subsections (a) and (b) of Section 1 of Article XI of the Original Indenture. 19
For the purposes of this Section 2 the following terms shall have the following meanings: "Capitalization" shall mean the sum of (i) the aggregate principal amount of all Debt at the time outstanding, (ii) the aggregate par or stated value of all capital stock of the Company of all classes at the time outstanding, (iii) premium on capital stock, (iv) capital surplus, and (v) retained earnings. "Debt" means (i) all indebtedness, whether or not represented by bonds, debentures, notes or other securities, for the repayment of money borrowed, (ii) all deferred indebtedness for the payment of the purchase price of property or assets purchased (but Debt shall not be deemed to include customer advances for construction or any bonds issued under the Indenture which are not Outstanding Bonds), (iii) leases which have been or, in accordance with generally accepted accounting principles, should be recorded as capital leases and (iv) guarantees of the obligations of another of the nature described in clauses (i), (ii) or (iii) which have been or, in accordance with generally accepted accounting principles, should be recorded as debt. "Determination Date" shall mean the last day of each calendar quarter. Any calculation with respect to any Determination Date shall be based on the Company's balance sheet as of such date. "Excluded Earnings" shall mean 35% of the Company's Net Income during any Restricted Period. "Net Income" for any particular Restricted Period shall mean the amount of net income properly attributable to the conduct of the business of the Company for such period, as determined in accordance with generally accepted accounting principles consistently applied, after payment of or provision for taxes on income for such period. "Outstanding Bonds" shall mean bonds which are outstanding within the meaning indicated in Section 20 of Article I of the Original Indenture except that, in addition to the bonds referred to in clauses (a), (b) and (c) of said Section 20, said term shall not include bonds for the retirement of which sufficient funds have been deposited with the Trustee with irrevocable instructions to apply such funds to the retirement of such bonds at a specified time, which may be either the maturity thereof or a specified redemption date, whether or not notice of redemption shall have been given. "Restricted Period" shall mean a period commencing on any Determination Date on which the total Debt of the Company is, or as the result of any Stock Payment then declared or set aside and to be made thereafter will be, more than 70% of Capitalization, and continuing until the third consecutive Determination Date on which the total Debt of the Company does not exceed 70% of Capitalization. 20
"Stock Payment" shall mean any payment in cash or property (other than stock of the Company) to any holder of shares of any class of capital stock of the Company as such holder, whether by dividend or upon the purchase, redemption, conversion or other acquisition of such shares, or otherwise. SECTION 3. The Company covenants and agrees that so long as any of the Bonds are outstanding, neither the Company nor any subsidiary of the Company will, directly or indirectly, lend or in any manner extend its credit to, or indemnify, or make any donation or capital contribution to, or purchase any security of, any corporation which directly or indirectly controls the Company, or any subsidiary or affiliate (other than an affiliate which is a subsidiary of the Company) of any such corporation. ARTICLE IV. The Trustee. SECTION 1. The Trustee hereby accepts the trust hereby declared and provided, and agrees to perform the same upon the terms and conditions in the Original Indenture, as supplemented by this Fortieth Supplemental Indenture. SECTION 2. Subject to the provisions of Article XIII of the Original Indenture, the Trustee may execute any of the trusts or powers hereof and perform any of its duties by or through and consult with attorneys, agents, officers or employees selected by the Trustee in its sole discretion. The Trustee shall be entitled to advice of counsel concerning all matters of trusts hereof and the duties hereunder and may in all cases pay such reasonable compensation to all such attorneys, agents, officers and employees as may reasonably be employed in connection with the trusts hereof. The Trustee may act or refrain from acting and rely upon and be free from all liability for so relying upon the opinion or advice of any attorney (who may be the attorney or attorneys for the Company). The Trustee may act and rely on written opinions of experts employed by the Trustee and such advice shall be full and complete authorization and protection in respect of any action taken, suffered or omitted by the Trustee hereunder in good faith and in reliance thereon. The Trustee shall not be responsible for any loss or damage resulting from any action or non-action in good faith taken in reliance upon such opinion or advice. The Trustee shall not be bound to confirm, verify or make any investigation into the facts or matters stated in any financial or other statements, resolution, certificate, statement, instrument, opinion, report, notice, request, direction, consent, order or other paper or document furnished pursuant to the terms hereof. SECTION 3. Before the Trustee shall be required to foreclose on, or to take control or possession of, the real property or leasehold interest (the "Premises") which may be the subject of any mortgage or mortgages for which the Trustee is mortgagee in connection with the issuance of the Bonds, the Trustee shall be indemnified and held harmless by the holders and/or beneficial owners of the Bonds from and against any and all expense, loss, or liability that may be suffered by the Trustee in connection with any spill, leak or release which may have occurred on or invaded the Premises or any contamination by any Hazardous Substance (hereinafter defined), whether caused by the Company or any other person or entity, including, but not limited to, (1) any and all reasonable expenses that the Trustee may incur in complying with any of the Environmental Statutes (hereinafter defined), (2) any and all reasonable costs that 21
the Trustee may incur in studying or remedying any spill, leak or release which may have occurred on or invaded the Premises or any contamination, (3) any and all fines or penalties assessed upon the Trustee by reason of such contamination, (4) any and all loss of value of the Premises or the improvements thereon by reason of such contamination, and (5) any and all legal fees and costs reasonably incurred by the Trustee in connection with any of the foregoing. As used in this Section, contamination by any Hazardous Substance shall include contamination, arising from the presence, creation, production, collection, treatment, disposal, discharge, release, storage, transport or transfer of any Hazardous Substance at or from the Premises or any improvements thereon. As used in this Section, the term "Hazardous Substance" shall mean petroleum hydrocarbons or any substance which (a) constitutes a hazardous waste or substance under any applicable federal, state or local law, rule, order or regulation now or hereafter adopted; (b) constitutes a "hazardous substance" as such term is defined under the Comprehensive Environmental Response, Compensation and Liability Act, as amended (42 U.S.C. ss.9601 et seq.) and the regulations issued thereunder and any comparable state or local law or regulation; (c) constitutes a "hazardous waste" under the Resource Conservation and Recovery Act, (42 U.S.C. ss.6991) and the regulations issued thereunder and any comparable state or local law or regulation; (d) constitutes a pollutant, contaminant, chemical or industrial, toxic or hazardous substance or waste as such terms are defined under Federal Clean Water Act, as amended (33 U.S.C. ss.1251 et seq.), the Toxic Substances Control Act, as amended (15 U.S.C. ss.2601 et seq.), or any comparable state or local laws or regulations; (e) exhibits any of the characteristics enumerated in 40 C.F.R. Sections 261.20 - 261.24, inclusive; (f) those extremely hazardous substances listed in Section 302 of the Superfund Amendments and Reauthorization Act of 1986 (Public Law 99-499, 100 Stat. 1613) which are present in threshold planning or reportable quantities as defined under such act; (g) toxic or hazardous chemical substances which are present in quantities which exceed exposure standards as those terms are defined under Sections 6 and 8 of the Occupational Safety and Health Act, as amended (29 U.S.C. ss.ss.655 and 657 and 29 C.F.R. Part 1910, subpart 2); and (h) any asbestos, petroleum-based products or any Hazardous Substance contained within or release from any underground or aboveground storage tanks. As used in this Section, the term "Environmental Statutes" shall mean the statutes, laws, rules, orders and regulations referred to in (a) through (g) inclusive in the preceding sentence. ARTICLE V. Miscellaneous. SECTION 1. This instrument is executed and shall be construed as an indenture supplemental to the Original Indenture, and shall form a part thereof, and except as hereby supplemented, the Original Indenture and the First, Second, Third, Fourth, Fifth, Sixth, Seventh, Eighth, Ninth, Tenth, Eleventh, Twelfth, Thirteenth, Fourteenth, Fifteenth, Sixteenth, Seventeenth, Eighteenth, Nineteenth, Twentieth, Twenty-First, Twenty-Second, Twenty-Third, Twenty-Fourth, Twenty-Fifth, Twenty-Sixth, Twenty-Seventh, Twenty-Eighth, Twenty-Ninth, Thirtieth, Thirty-First, Thirty-Second, Thirty-Third, Thirty-Fourth, Thirty-Fifth, Thirty-Sixth, Thirty-Seventh, Thirty-Eighth and Thirty-Ninth Supplemental Indentures are hereby confirmed. All references in this Fortieth Supplemental Indenture to the Original Indenture shall be deemed to refer to the Original Indenture as heretofore amended and supplemented, and all terms used herein and not specifically defined herein shall be taken to have the same meaning as in the Original Indenture, as so amended, except in the cases where the context clearly indicates otherwise. 22
SECTION 2. Any notices to the Trustee under this Fortieth Supplemental Indenture shall be delivered to the Trustee by registered or certified mail, hand delivery or other courier or express delivery service (with receipt confirmed) or by telecopy (with receipt confirmed) at the following address: J.P. Morgan Trust Company, National Association Worldwide Securities Services c/o JPMorgan Chase Bank, N.A. 4 NY Plaza New York, New York 10004 Attention: Aqua Pennsylvania, Inc. Administrator Telecopy: (212) 623-6205 Any change in such address or telecopy number may be made by notice to the Company delivered in the manner set forth above. SECTION 3. All recitals in this Fortieth Supplemental Indenture are made by the Company only and not by the Trustee; and all of the provisions contained in the Original Indenture in respect of the rights, privileges, immunities, powers and duties of the Trustee shall be applicable in respect hereof as fully and with like effect as if set forth herein in full. SECTION 4. Although this Fortieth Supplemental Indenture is dated as of December 15, 2005 for convenience and for the purpose of reference, the actual date or dates of execution hereof by the Company and the Trustee are as indicated by their respective acknowledgments annexed hereto. SECTION 5. In order to facilitate the recording or filing of this Fortieth Supplemental Indenture, the same may be simultaneously executed in several counterparts, each of which shall be deemed to be an original and such counterparts shall together constitute but one and the same instrument. SECTION 6. This Fortieth Supplemental Indenture shall become effective for the incurrence of debt upon delivery to the Trustee by the Company of the certificates required by Articles IV, VI and VII of the Original Indenture, which shall occur concurrently with or prior to the authentication of the 5.00% Series due 2035. This Fortieth Supplemental Indenture is effective to evidence the Trustee's lien on the property described herein immediately upon execution. 23
IN WITNESS WHEREOF the parties hereto have caused their corporate seals to be hereunto affixed and their authorized officers have hereto affixed their signatures, and their authorized officers have duly attested the execution hereof, this ___ day of December , 2005. [CORPORATE SEAL] AQUA PENNSYLVANIA, INC., as successor by merger to Philadelphia Suburban Water Company Attest: /s/ Roy H. Stahl By: /s/ Kathy L. Pape -------------------------- ------------------------------- Vice President and Treasurer [CORPORATE SEAL] J.P. MORGAN TRUST COMPANY, NATIONAL ASSOCIATION, As Trustee Attest: /s/ Beth Ann MacDonald By: /s/ Catherine Duffy -------------------------- ------------------------------- Authorized Officer Authorized Signatory 24
EXHIBIT A AQUA PENN SYLVANIA, INC. SCHEDULE OF FIRST MORTGAGE BONDS AS OF DECEMBER 15, 2005 Interest Issue Maturity Original Balance (incl. CP) Division Structure Rate Date Date Amount @ 12/15/05 - -------- --------- -------- ----- -------- ---------- ------------------- Aqua Pa Tax Exempt 5.35% 11/01/01 10/01/31 30,000,000 30,000,000 Aqua Pa Tax Exempt 5.55% 06/01/02 09/01/32 25,000,000 25,000,000 Shenango Tax Exempt 6.00% 10/01/99 06/01/29 25,000,000 25,000,000 Aqua Pa Tax Exempt 6.00% 06/28/00 07/01/30 18,360,000 18,360,000 Roaring Creek Tax Exempt 5.05% 11/30/04 10/01/39 14,000,000 14,000,000 Aqua Pa Tax Exempt 3.75% 12/31/02 06/01/10 3,200,000 2,000,000 Aqua Pa Tax Exempt 5.15% 06/26/02 09/01/32 25,000,000 25,000,000 Aqua Pa Tax Exempt 5.00% 05/19/05 11/01/36 21,770,000 21,770,000 Aqua Pa Tax Exempt 5.00% 05/19/05 11/01/37 24,165,000 24,165,000 Aqua Pa Tax Exempt 5.00% 05/19/05 11/01/38 25,375,000 25,375,000 ----------- ----------- 211,870,000 210,670,000 ----------- ----------- Aqua Pa Taxable 5.93% 06/26/02 07/01/12 25,000,000 25,000,000 Aqua Pa Taxable 6.14% 01/15/98 02/01/08 10,000,000 10,000,000 Aqua Pa Taxable 6.21% 10/25/01 11/01/11 15,000,000 15,000,000 Aqua Pa Taxable 6.75% 07/15/97 08/15/07 10,000,000 10,000,000 Aqua Pa Taxable 6.89% 12/19/95 12/15/15 12,000,000 12,000,000 Aqua Pa Taxable 6.99% 04/12/96 04/15/06 10,000,000 10,000,000 Aqua Pa Taxable 7.15% 04/23/93 04/01/08 22,000,000 6,000,000 Aqua Pa Taxable 7.72% 05/19/95 05/15/25 15,000,000 15,000,000 Shenango Taxable 8.14% 11/01/95 11/01/25 4,000,000 4,000,000 Susquehanna Taxable 8.26% 11/01/92 11/01/22 1,500,000 1,500,000 Shenango Taxable 8.32% 11/01/92 11/01/22 3,500,000 3,500,000 Aqua Pa Taxable 9.12% 01/12/90 01/15/10 20,000,000 20,000,000 Aqua Pa Taxable 9.17% 11/01/91 09/15/21 8,000,000 6,400,000 Aqua Pa Taxable 9.17% 11/01/91 09/15/11 5,000,000 5,000,000 Shenango Taxable 9.22% 11/15/89 11/15/19 3,500,000 2,212,640 Aqua Pa Taxable 9.29% 11/01/91 09/15/26 12,000,000 12,000,000 Shenango Taxable 9.50% 09/12/86 09/12/06 3,000,000 960,000 Roaring Creek Taxable 9.53% 12/15/89 12/15/19 4,000,000 4,000,000 Aqua Pa Taxable 9.89% 06/01/88 06/01/08 5,000,000 5,000,000 Aqua Pa Taxable 9.93% 06/01/88 06/01/13 5,000,000 5,000,000 Aqua Pa Taxable 9.97% 06/01/88 06/01/18 5,000,000 5,000,000 Aqua Pa Taxable 2.65% 05/10/04 05/15/06 5,000,000 5,000,000 Aqua Pa Taxable 3.461% 05/10/04 05/15/07 12,000,000 12,000,000 Aqua Pa Taxable 5.08% 05/10/04 05/15/15 20,000,000 20,000,000 Aqua Pa Taxable 5.17% 05/10/04 05/10/17 7,000,000 7,000,000 Aqua Pa Taxable 5.751% 05/10/04 05/15/19 15,000,000 15,000,000 Aqua Pa Taxable 5.751% 05/10/04 05/15/19 5,000,000 5,000,000 Aqua Pa Taxable 6.06% 05/10/04 05/10/27 15,000,000 15,000,000 Aqua Pa Taxable 6.06% 05/10/04 05/15/27 5,000,000 5,000,000 Aqua Pa Taxable 5.98% 05/10/04 05/15/28 3,000,000 3,000,000 ----------- ----------- 285,500,000 264,572,640 ----------- ----------- TOTAL FIRST MORTGAGE BONDS 497,370,000 475,242,640 =========== ===========
EXHIBIT B RECORDING INFORMATION BUCKS, CHESTER, DELAWARE AND MONTGOMERY COUNTIES ============================ ============= ========================== =============================== Bucks Chester - ---------------------------- ------------- -------------------------- ------------------------------- Date of Indenture Recording Book Page Book Page - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Original 2/20/41 496 1 H-13.Vol.307 20 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- First Supplemental 8/26/48 632 1 F-16.Vol.380 200 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Second Supplemental 7/1/52 768 438 18.Vol.425 186 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Third Supplemental 11/25/53 895 1 18.Vol.442 325 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Fourth Supplemental 1/9/56 1089 155 Z-20.Vol.499 1 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Fifth Supplemental 3/20/57 1181 316 B-22.Vol.536 601 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Sixth Supplemental 5/9/58 1254 1 G-23 201 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Seventh Supplemental 9/25/59 1332 509 B-25 109 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Eighth Supplemental 5/9/61 - - Z-26 17 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Eighth Supplemental 5/10/61 1409 225 - - - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Ninth Supplemental 4/10/62 1458 372 G-28 126 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Tenth Supplemental 3/19/64 1568 1 M-30 967 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Eleventh Supplemental 11/4/66 1655 695 Q-32 6682 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twelfth Supplemental 1/23/68 1691 531 N-33 219 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Thirteenth Supplemental 7/2/70 1763 1167 D-35 80 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Fourteenth Supplemental 11/5/70 1774 331 K-35 713 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Fifteenth Supplemental 12/11/72 1869 196 O-37 998 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Sixteenth Supplemental 5/28/75 1979 14 E-44 77 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Seventeenth Supplemental 12/18/77 2072 683 L-51 1 - ---------------------------- ------------- -------- ----------------- ---------------- --------------
[RESTUBBED] ============================ ============= =============================== ============================= Delaware Montgomery - ---------------------------- ------------- ------------------------------- ----------------------------- Date of Indenture Recording Book Page Book Page - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Original 2/20/41 1034 1 1625 1 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- First Supplemental 8/26/48 1668 169 2031 257 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Second Supplemental 7/1/52 1962 376 2360 517 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Third Supplemental 11/25/53 2052 1 2493 1 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Fourth Supplemental 1/9/56 2199 1 2722 425 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Fifth Supplemental 3/20/57 2294 50 2850 335 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Sixth Supplemental 5/9/58 2380 039 2952 289 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Seventh Supplemental 9/25/59 2442 1 3090 249 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Eighth Supplemental 5/9/61 2526 312 - - - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Eighth Supplemental 5/10/61 - - 3249 289 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Ninth Supplemental 4/10/62 2581 463 3307 169 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Tenth Supplemental 3/19/64 2976 1043 3310 237 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Eleventh Supplemental 11/4/66 762 223 3549 129 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twelfth Supplemental 1/23/68 2792 708 3542 315 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Thirteenth Supplemental 7/2/70 2850 301 3687 23 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Fourteenth Supplemental 11/5/70 2858 3113 700 548 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Fifteenth Supplemental 12/11/72 2926 550 3786 96 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Sixteenth Supplemental 5/28/75 3005 511 4010 307 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Seventeenth Supplemental 12/18/77 3072 43 5002 436 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- B-1
============================ ============= ========================== =============================== Bucks Chester - ---------------------------- ------------- -------------------------- ------------------------------- Date of Indenture Recording Book Page Book Page - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Eighteenth Supplemental 4/29/77 2082 567 B-52 344 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Nineteenth Supplemental 6/23/80 2303 714 J-62 92 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twentieth Supplemental 8/2/83 2487 370 D-72 1 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twenty-First Supplemental 8/27/85 2690 806 54 550 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twenty-First Supplemental 8/28/85 - - - - - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twenty-Second Supplemental 4/22/86 2774 160 263 275 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twenty-Third Supplemental 4/1/87 2960 693 - - - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twenty-Third Supplemental 4/2/87 - - 680 337 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twenty-Fourth Supplemental 7/25/88 3199 1095 1224 389 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twenty-Fifth Supplemental 1/12/90 0136 0250 1848 205 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twenty-Sixth Supplemental 11/8/91 369 2190 2660 205 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twenty-Seventh Supplemental 6/29/92 0487 1829 3055 182 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twenty-Eighth Supplemental 4/22/93 0652 1335 3542 1542 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Twenty-Ninth Supplemental 3/30/95 1045 1872 3875 1368 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Thirtieth Supplemental 8/30/95 1111 0798 3932 0471 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Thirty-First Supplemental 7/11/97 1421 2196 4201 2133 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Thirty-Second Supplemental 10/6/99 1939 421 4646 642 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Thirty-Third Supplemental 11/30/99 1970 1573 4675 1272 - ---------------------------- ------------- -------- ----------------- ---------------- --------------
[RESTUBBED] ============================ ============= =============================== ============================= Delaware Montgomery - ---------------------------- ------------- ------------------------------- ----------------------------- Date of Indenture Recording Book Page Book Page - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Eighteenth Supplemental 4/29/77 3078 728 5003 291 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Nineteenth Supplemental 6/23/80 3261 293 5030 502 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twentieth Supplemental 8/2/83 96 810 5662 1045 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twenty-First Supplemental 8/27/85 - - 5864 1347 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twenty-First Supplemental 8/28/85 264 159 - - - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twenty-Second Supplemental 4/22/86 326 592 5944 360 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twenty-Third Supplemental 4/1/87 - - - - - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twenty-Third Supplemental 4/2/87 447 1807 6115 602 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twenty-Fourth Supplemental 7/25/88 0593 0585 6324 143 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twenty-Fifth Supplemental 1/12/90 731 1571 6538 376 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twenty-Sixth Supplemental 11/8/91 894 2241 6780 891 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twenty-Seventh Supplemental 6/29/92 0969 2023 6918 302 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twenty-Eighth Supplemental 4/22/93 1081 0852 7112 0539 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Twenty-Ninth Supplemental 3/30/95 1349 0829 7561 1155 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Thirtieth Supplemental 8/30/95 1393 2255 7631 0689 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Thirty-First Supplemental 7/11/97 1607 138 7968 779 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Thirty-Second Supplemental 10/6/99 1936 1207 8548 1067 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Thirty-Third Supplemental 11/30/99 1936 1207 8548 1067 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- B-2
============================ ============= ========================== =============================== Bucks Chester - ---------------------------- ------------- -------------------------- ------------------------------- Date of Indenture Recording Book Page Book Page - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Thirty-Fourth Supplemental 10/31/01 2471 1207 5101 2142 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Thirty-Fifth Supplemental 1/10/02 2541 765 5152 818 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Thirty-Sixth Supplemental 6/5/02 2731 1881 5296 356 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Thirty-Seventh Supplemental 12/27/02 3036 1425 12/31/02 1552 B-5514 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Thirty-Eighth Supplemental 11/9/04 4196 1557 11/23/04 800 B-6342 - ---------------------------- ------------- -------- ----------------- ---------------- -------------- Thirty-Ninth Supplemental 5/18/05 4441 1471 5/19/05 1375 #2005066104 6496 #10534807 ============================ ============= ======== ================= ================ ============== [RESTUBBED] ============================ ============= =============================== ============================= Delaware Montgomery - ---------------------------- ------------- ------------------------------- ----------------------------- Date of Indenture Recording Book Page Book Page - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Thirty-Fourth Supplemental 10/31/01 2288 0174 9225 761 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Thirty-Fifth Supplemental 1/10/02 2329 1019 9314 1079 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Thirty-Sixth Supplemental 6/5/02 2448 1862 9593 1416 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Thirty-Seventh Supplemental 12/27/02 12/31/02 0294 12/30/02 0204 02631 10018 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Thirty-Eighth Supplemental 11/9/04 11/22/04 1698 11/22/04 0237 B-3348 B-00020 - ---------------------------- ------------- ------------ ------------------ ------------ ---------------- Thirty-Ninth Supplemental 5/18/05 03487 0939 0020 0688 32005044507 2005069126 ============================ ============= ============ ================== ============ ================ BERKS COUNTY =========================== ==================== ========= ========== Indenture Date of Recording Book Page - --------------------------- -------------------- --------- ---------- Original 8/16/99 3113 707 - --------------------------- -------------------- --------- ---------- Thirty-Second Supplemental 10/6/99 3132 1510 - --------------------------- -------------------- --------- ---------- Thirty-Third Supplemental 11/30/99 3149 1260 - --------------------------- -------------------- --------- ---------- Thirty-Fourth Supplemental 10/31/01 3421 896 - --------------------------- -------------------- --------- ---------- Thirty-Fifth Supplemental 1/10/02 3461 417 - --------------------------- -------------------- --------- ---------- Thirty-Sixth Supplemental 6/4/02 3544 1357 - --------------------------- -------------------- --------- ---------- Thirty-Seventh Supplemental 12/30/02 3664 0001 - --------------------------- -------------------- --------- ---------- Thirty-Eighth Supplemental 11/30/04 4197 988 - --------------------------- -------------------- --------- ---------- Thirty-Ninth Supplemental 5/18/05 04583 1017 =========================== ==================== ========= ========== B-3
BRADFORD, COLUMBIA, LAWRENCE, MERCER, NORTHUMBERLAND, PIKE, SCHUYLKILL AND WAYNE COUNTIES ================== ========================= ========================= ================================= ========================= BRADFORD COLUMBIA LAWRENCE MERCER - ------------------ ------------------------- ------------------------- --------------------------------- ------------------------- Date of Instrument Date of Instrument Date of Date of Instrument Indenture Recording No. Recording No. Recording Book Page Recording No. - ------------------ ------------ ------------ ------------ ------------ ------------ ------- ------------ ----------- ------------- Thirty-Fifth 12/21/01 200115497 1688 744 Supplemental - ------------------ ------------ ------------ ------------ ------------ ------------ ------- ------------ ----------- ------------- Thirty-Sixth 07/04/02 200207151 Supplemental - ------------------ ------------ ------------ ------------ ------------ ------------ ------- ------------ ----------- ------------- Thirty-Seventh 12/30/02 200216472 Supplemental - ------------------ ------------ ------------ ------------ ------------ ------------ ------- ------------ ----------- ------------- Thirty-Eighth 11/22/04 200415112 11/30/04 200413567 11/24/04 1992 0291 11/24/04 2004020435 Supplemental - ------------------ ------------ ------------ ------------ ------------ ------------ ------- ------------ ----------- ------------- Thirty-Ninth 5/16/05 200504827 5/18/05 200505042 5/16/2005 2032 200 5/13/05 2005-7340 Supplemental #005488 ================== ============ ============ ============ ============ ============ ======= ============ =========== ============= ================== ======================================= ===================================== NORTHUMBERLAND PIKE - ------------------ --------------------------------------- ------------------------------------- Date of Date of Indenture Rec. Book Page Rec. Book Page - ------------------ ---------- ------------- -------------- ---------- -------- ----------------- Thirty-Fifth 1404 246 1909 2328 Supplemental - ------------------ ---------- ------------- -------------- ---------- -------- ----------------- Thirty-Sixth 1445 028 Supplemental - ------------------ ---------- ------------- -------------- ---------- -------- ----------------- Thirty-Seventh 12/30/02 1500 911 12/30/02 1959 2447 Supplemental - ------------------ ---------- ------------- -------------- ---------- -------- ----------------- Thirty-Eighth 11/22/04 1714 748 11/23/04 2081 1757 Supplemental - ------------------ ---------- ------------- -------------- ---------- -------- ----------------- Thirty-Ninth 5/18/05 1761 50 5/17/05 2109 2201 Supplemental #200509076 #200500008491 ================== ========== ============= ============== ========== ======== ================= [RESTUBBED] ================== ===================================== ===================================== SCHUYLKILL WAYNE - ------------------ ------------------------------------- ------------------------------------- Date of Date of Indenture Rec. Book Page Rec. Book Page - ------------------ ---------- --------- ---------------- ----------- -------- ---------------- Thirty-Fifth 1413 1 1911 1 Supplemental - ------------------ ---------- --------- ---------------- ----------- -------- ---------------- Thirty-Sixth 1584 0259 Supplemental - ------------------ ---------- --------- ---------------- ----------- -------- ---------------- Thirty-Seventh 12/27/02 2022 1006 12/30/02 2136 148 Supplemental - ------------------ ---------- --------- ---------------- ----------- -------- ---------------- Thirty-Eighth 11/24/04 2126 569 11/23/04 2658 252 Supplemental - ------------------ ---------- --------- ---------------- ----------- -------- ---------------- Thirty-Ninth 5/18/05 2150 1871-1919 5/16/05 Vol. 1 Supplemental #200500010263 2769 #200500004960 ================== ========== ========= ================ =========== ======== ================ B-4
ADAMS, CARBON, CUMBERLAND, FOREST, JUNIATA, LACKAWANNA, LUZERNE, MONROE, NORTHAMPTION, SNYDER, SUSQUEHANNA AND WYOMING COUNTIES ================== =========================== ======================================= ADAMS CARBON - ------------------ --------------------------- --------------------------------------- Date of Date of Indenture Rec. Book Page Rec. Book Page - ------------------ ---------- -------- ------- ---------- ------------- -------------- Thirty-Eighth 11/23/04 3781 1 11/30/04 200416309 Supplemental - ------------------ ---------- -------- ------- ---------- ------------- -------------- Thirty-Ninth 5/19/05 3970 54 5/18/05 1330 689 Supplement #200505926 ================== ========== ======== ======= ========== ============= ============== [RESTUBBED] ================== ================================= ============================ CUMBERLAND FOREST - ------------------ --------------------------------- ---------------------------- Date of Date of Indenture Rec. Book Page Rec. Book Page - ------------------ ---------- -------------- ------- ------------ -------- ------ Thirty-Eighth 11/22/04 2004047145 11/29/04 231 306 Supplemental - ------------------ ---------- -------------- ------- ------------ -------- ------ Thirty-Ninth 5/13/05 1907 0247 5/16/05 234 345 Supplement #478 ================== ========== ============== ======= ============ ======== ======
================== ================================== ================================= JUNIATA LACKAWANNA - ------------------ ---------------------------------- --------------------------------- Date of Date of Indenture Rec. Book Page Rec. Book Page - ------------------ ---------- -------- -------------- ------------ ------------- ------ Thirty-Eighth 11/22/04 345 1047 11/29/04 #200441665 Supplemental - ------------------ ---------- -------- -------------- ------------ ------------- ------ Thirty-Ninth 5/13/05 354 0049 5/16/05 #200512642 Supplemental #2005-1512 ================== ========== ======== ============== ============ ============= ====== [RESTUBBED] ================== =================================== ==================================== LUZERNE MONROE - ------------------ ----------------------------------- ------------------------------------ Date of Date of Indenture Rec. Book Page Recording Book Page - ------------------ ------------ --------- ------------ ------------ -------- -------------- Thirty-Eighth 11/23/04 3004 294775 11/24/04 2208 7674 Supplemental - ------------------ ------------ --------- ------------ ------------ -------- -------------- Thirty-Ninth 5/17/05 3005 117727 5/18/05 2225 8444 Supplemental #5637329 #200521128 ================== ============ ========= ============ ============ ======== ==============
================== ================================== ================================ NORTHAMPTON SNYDER - ------------------ ---------------------------------- -------------------------------- Date of Date of Indenture Rec. Book Page Rec. Book Page - ------------------ --------- --------- -------------- --------- -------- ------------- Thirty-Eighth 11/22/04 2004-1 452932 11/24/04 631 0001 Supplemental - ------------------ --------- --------- -------------- --------- -------- ------------- Thirty-Ninth 5/17/05 2005-1 182906 5/17/05 650 135 Supplemental #2005026917 #2005028880 ================== ========= ========= ============== ========= ======== ============= [RESTUBBED] ================== =============================== ============================== SUSQUEHANNA WYOMING - ------------------ ------------------------------- ------------------------------ Date of Date of Indenture Rec. Book Page Rec. Book Page - ------------------ ---------- ------------ ------- ---------- -------- ---------- Thirty-Eighth 11/24/04 200411624 11/24/04 0513 0774 Supplemental - ------------------ ---------- ------------ ------- ---------- -------- ---------- Thirty-Ninth 5/16/05 #200504384 5/18/05 0522 1289 Supplemental ================== ========== ============ ======= ========== ======== ========== B-5
EXHIBIT C Company's County and Real Estate Recorded Tax Parcel Grantor Index No. Date of Deed Book Page I.D. Number - ------- --------- ------------ ---- --------- ----------- NONE C-1
J.P. Morgan Trust Company National Association, Mortgagee and Trustee named in the foregoing Fortieth Supplemental Indenture, hereby certifies that its precise name and the post office address of its Worldwide Securities Services Group in New York, New York, Pennsylvania are as follows: J.P. Morgan Trust Company, National Association Worldwide Securities Services Group c/o JPMorgan Chase Bank, N.A. 4 NY Plaza New York, New York 10004 Attention: Aqua Pennsylvania, Inc. Administrator Telecopy: (212) 623-6205 J.P. MORGAN TRUST COMPANY, NATIONAL ASSOCIATION By: /s/ Catherine Duffy ------------------------ Authorized Signatory
COMMONWEALTH OF PENNSYLVANIA COUNTY OF MONTGOMERY On the 21st day of December, 2005, before me, the Subscriber, a Notary Public for the Commonwealth of Pennsylvania, personally appeared Kathy L. Pape, who acknowledged herself to be the Vice President and Treasurer of Aqua Pennsylvania, Inc., a corporation, and that she as such Vice President and Treasurer, being authorized to do so, executed the foregoing Fortieth Supplemental Indenture as and for the act and deed of said corporation and for the uses and purposes therein mentioned, by signing the name of the corporation by herself as such officer. In Witness Whereof I hereunto set my hand and official seal. [NOTARIAL SEAL] /s/ Maria Gordiany -------------------------
COMMONWEALTH OF PENNSYLVANIA COUNTY OF PHILADELPHIA On the 21st day of December, 2005 before me, the Subscriber, a Notary Public for the Commonwealth of Pennsylvania, personally appeared CatherineDuffy, who acknowledged herself to be an authorized signatory of J.P. Morgan Trust Company, National Association, Trustee, a national banking association, and that she as such authorized signatory, being authorized to do so, executed the foregoing Fortieth Supplemental Indenture as and for the act and deed of said national banking association and for the uses and purposes therein mentioned by signing the name of said national banking association by herself as such officer. In Witness Whereof I hereunto set my hand and official seal. [NOTARIAL SEAL] /s/ John Sohier -------------------------
EXHIBIT 10.30 AQUA AMERICA, INC. AND SUBSIDIARIES 2006 ANNUAL CASH INCENTIVE COMPENSATION PLAN BACKGROUND o In 1989, the Company and its compensation consultant conducted a feasibility study to determine whether the Company should implement an incentive compensation plan. The study was prompted by the positive experience of other investor-owned water companies with incentive compensation. o The study included interviews with executives and an analysis of competitive compensation levels. Based on the results, the compensation consultant recommended that the Company's objectives and competitive practice supported the adoption of an annual incentive plan (the "Plan"). The Company has had a cash incentive compensation plan in place since 1990 and management and the Board of Directors believe it has had a positive effect on the Company's operations, aiding employees, shareholders (higher earnings) and customers (better service and controlling expenses). o The Plan has two components - a Management Incentive Program and an Employee Recognition ("Chairman's Award") Program. o The Plan is designed to provide an appropriate incentive to the officers, managers and certain other key employees of the Company. The 2006 Management Incentive Program will cover officers, managers and certain key employees of Aqua America, Inc., and its subsidiaries. o All incentive awards under the Plan shall be paid by March 15 of the calendar year following the calendar year in which such awards are earned, or as soon as administratively practicable thereafter. MANAGEMENT INCENTIVE PROGRAM o PERFORMANCE MEASURES -- Annual incentive bonus awards are calculated by multiplying an individual's Target Bonus by a Company Rating Factor based on the applicable company's performance and an Individual Rating Factor based on the individual employee's performance.
The approach of having a plan tied to the applicable company's income performance is appropriate as the participants' assume some of the same risks and rewards as the shareholders who are investing in the company and making its capital construction and acquisition programs possible. Customers also benefit from the participants' ?individual objectives being met, as improvements in performance are accomplished by controlling costs, improving efficiencies and enhancing customer service. For these reasons, future rate relief should be lessened and less frequent, which directly benefits all customers. -- The applicable company's actual after-tax net income from continuing operations or earnings before interest, taxes and depreciation ("EBITD") relative to its annual budget will be the primary measure for the company's performance. The measurement to be used as the Company Factor (financial factor, thresholds and weighting by applicable business unit) for each participant will be established by the Chairman of the Company and, for the senior executives of the Company, approved individually by the Executive Compensation and Employee Benefits Committee. Each year a "Target Net Income or EBITD" level will be established. Starting in 2000, portions of the Company Rating Factor may be tied to the financial targets of more than one company for some participants. For purposes of the Plan, the Target Net Income or EBITD may differ from the budgeted net income or EBITD level. For 2006, the Target Net Income or EBITD will exclude the impact of any unbudgeted extraordinary gains or losses as a result of changes in accounting principles. -- Based on a review of historic performance, the minimum or threshold level of performance is set at 90 percent of the Target Net Income or EBITD. That is, no bonus awards will be made if actual net income is less than 90 percent of the Target or EBITD for the year. No additional bonus will be earned for results exceeding 110 percent of the Target Net Income or EBITD. -- Each individual's performance and achievement of his or her objectives will also be evaluated and factored into the bonus calculation (the "Individual Factor"). Performance objectives for each participant are established at the beginning of the year and are primarily directed toward controlling costs, improving efficiencies and productivity, enhancing customer service and growing the company's customer base. Each objective has specific performance measures that are used to determine the level of achievement for each objective. A participant's target Individual Factor should be no more than 90 points, with the possibility of additional points being awarded for measurable performance above the participant's targeted performance level. Participants must achieve at least 70 points for their Individual Factor to be eligible for a bonus award under the Plan.
o PARTICIPATION -- Eligible participants consist of officers, managers and certain key employees. -- Participation in the Management Incentive Program will be determined each year. Each participant will be assigned a "Target Bonus Percentage" ranging from 5 to 70 percent depending on duties and responsibilities. The Executive Compensation and Employee Benefits Committee will approve the Target Bonus Percentage for the CEO and the senior executives designated by the Committee each year. -- For each company, the Target Bonus Percentage for each participant within that company will be applied to their base salary. -- Actual bonuses may range from 0, if the company's financial results falls below the minimum threshold or the participant does not make sufficient progress toward achieving his or her objectives (i.e. performance measure points totaling less than 70 points), to 187.5 percent if performance -- both Company and individual -- is rated at the maximum. -- New employees who are hired into a position that is eligible to participate in the Management Incentive Plan, will normally be eligible to receive a portion of the bonus calculated in accordance with this Plan that is pro-rated based on the number of full calendar months between the new employee's hire date and the end of the calendar year. -- Employees who would otherwise be eligible to participate in this Management Incentive Plan, but who leave employment with the company, either voluntarily, involuntarily or as a result of retirement, prior to the end of the Company's fiscal year will not receive a bonus for the year in which their employment terminates. If an employee who would otherwise be eligible to participate in this Management Incentive Plan dies, the company will pay the deceased employee's estate a portion of the bonus the deceased employee would otherwise have been entitled to assuming a 100% Individual Rating Factor, but pro-rated for the number of full calendar months the employee completed before his or her death.
o COMPANY PERFORMANCE -- Company performance will be measured on the following schedule: Percent of Company Target Rating ------ ------ Threshold.............. <90% 0% 90 50 92 65 95 80 96 85 97 90 98 94 99 97 Plan................... 100 100 105 110 >110 125 -- The actual Company Factor should be calculated by interpolation between the points shown in the table above. -- Regardless of the Company rating resulting from this Schedule, the Executive Compensation and Employee Benefits Committee retains the authority to determine the final Company Rating for purposes of this Plan. o INDIVIDUAL PERFORMANCE -- Individual performance will be measured on the following scale: Performance Measure Individual Points Rating Factor ------ ------------- 0 - 69 0% 70 70% 80 80% 90 90% 100 100% 110 110% -- In addition, up to 40 additional points and additional percentage points may be awarded to a participant at the discretion of the Chief Executive Officer for exemplary performance. Individual performance points for the Chief Executive Officer are determined by the Executive Compensation and Employee Benefits Committee.
SAMPLE CALCULATIONS o Example 1 Salary or $70,000 Target Bonus 10 percent ($7,000) Company Rating 100 percent Individual Rating 90 percent Calculation: Individual Company Individual Target Bonus x Rating x Rating = Bonus Earned ------------ ------ ------ ------------ $7,000 x 100% x 90% = $6,300 o Example 2 -- Using the same salary and target bonus, but assuming Company performance was less than 90 percent of Target EBITD, there would be no bonus earned. Calculation: $7,000 x 0 x 90% = 0 o Example 3 -- Similarly, if the Individual Factor is rated below 70 points, no bonus would be earned regardless of the Company Factor. Calculation: $7,000 x 100% x 0 = 0
o Example 4 -- If the Company Rating Factor is allocated between two companies, the bonus will be calculated separately based on the allocation. Calculation: Company Company Individual Target Bonus x Rating x Allocation x Rating = Bonus Earned - ------------ ------ ---------- ------ ------------ $7,000 x 100% x 20% x 90% = $1,260 $7,000 x 110% x 80% x 90% = $5,544 ------ Total Bonus = $6,804 o Example 5 -- It is also possible that one portion of the applicable Company Rating Factor is zero, for which there would be no bonus, regardless of the participant's Individual Rating Factor. Calculation: Company Company Individual Target Bonus x Rating x Allocation x Rating = Bonus Earned - ------------ ------ ---------- ------ ------------ $7,000 x 0% x 20% x 90% = $0 $7,000 x 110% x 80% x 90% = $5,544 ------ Total Bonus = $5,544
EMPLOYEE RECOGNITION ("CHAIRMAN'S AWARD") PROGRAM 1. In addition to the Management Incentive Program, the Company maintains an Employee Recognition Program known as the Chairman's Award program to reward non-union employees not eligible for the management bonus plan for superior performance that contains costs, improves efficiency and productivity of the workforce and better serves our customers. Awards may also be made for a special action or heroic deed, or for a project that positively impacts the performance or image of the Company. 2. Awards will be made from an annual pool designated by the Chairman of Aqua America with the approval of the Executive Compensation and Employee Benefits Committee. Unused funds will not be carried over to the next year. If financial performance warrants, management may request special awards under the program. 3. In general, Chairman's Awards will not be made to employees of a company that does not achieve at least 90% of its net income objective for the year. 4. Awards may be made throughout the year, however, no more than one-third of a company's Chairman's Award pool may be awarded until the company's final net income for the year is determined. 5. Nominations for employees to receive Chairman's Awards will be made to the applicable officer and should include documentation on the reasons for the recommendations. The applicable officer will review the nominations and forward their recommendations to the Chairman of Aqua America. 6. The Chairman will determine the individuals to actually receive a bonus and the amount. The maximum award to any one employee is $5,000.
Exhibit 10.37 BOND PURCHASE AGREEMENT $24,675,000 DELAWARE COUNTY INDUSTRIAL DEVELOPMENT AUTHORITY WATER FACILITIES REVENUE BONDS (AQUA PENNSYLVANIA INC. PROJECT) SERIES C OF 2005 Bond Purchase Agreement dated December 21, 2005, among the DELAWARE COUNTY INDUSTRIAL DEVELOPMENT AUTHORITY (the "Authority"), AQUA PENNSYLVANIA, INC., a Pennsylvania corporation (the "Company"), and SOVEREIGN SECURITIES CORPORATION, LLC, a Pennsylvania limited liability company (the "Underwriter"). 1. BACKGROUND. (a) The Authority proposes to enter into a Financing Agreement (the "Financing Agreement") dated as of December 15, 2005 with the Company, under which the Authority will agree to loan to the Company funds to (i) finance certain capital costs of numerous acquisitions, constructions, modifications, expansions, installations and replacements of water distribution, treatment and related operating systems located in the counties of Chester, Delaware and Montgomery in Pennsylvania (the "Facilities") that are part of the Company's system (the "System") for the distribution of water to its customers, and (ii) pay related financing costs (collectively, the "Project"). To finance the loan under the Financing Agreement, the Authority proposes to issue and sell $24,675,000 aggregate principal amount of Delaware County Industrial Development Authority Water Facilities Revenue Bonds (Aqua Pennsylvania, Inc. Project), Series C of 2005 (the "Bonds") to the Underwriter, who will in turn reoffer the Bonds for sale to the public. (b) The Bonds will be issued pursuant to the Pennsylvania Economic Development Financing Law, Act of August 23, 1967, P.L. 251, as amended and supplemented (the "Act"), a resolution adopted by the Authority on November 18, 2005 (the "Authority Resolution") and under a Trust Indenture dated as of December 15, 2005 (the "Trust Indenture"), between the Authority and Wachovia Bank, National Association, as trustee (the "Trustee"). The Bonds will have such terms as are set forth in Schedule I attached hereto. The Bonds will be payable out of payments by the Company under the Financing Agreement, including payments under its First Mortgage Bond issued with respect to the Bonds in the aggregate principal amount of $24,675,000 (the "First Mortgage Bond"). The First Mortgage Bond will be issued under and secured by the Company's Indenture of Mortgage dated as of January 1, 1941 (the "Indenture of Mortgage"), from the Company to J.P. Morgan Trust Company, National Association, as trustee (successor to The Pennsylvania Company for Insurance on Lives and Granting Annuities, The Pennsylvania Company for Banking and Trusts, The First Pennsylvania Banking and Trust Company, First Pennsylvania Bank, N.A., CoreStates Bank, N.A., Mellon Bank, N.A. and Chase Manhattan Trust Company, National Association) (the "Mortgage Trustee"), as presently amended and supplemented and as to be further supplemented by a Fortieth Supplemental Indenture of Mortgage to be dated as of December 15, 2005 (the "Fortieth Supplemental Mortgage," which together with the Indenture of Mortgage, as amended and supplemented, is referred to hereinafter as the "Mortgage"). The First Mortgage Bond will be issued in the same principal amount and will mature on the same date and bear interest at the same rate as the Bonds that it secures. All of the Authority's rights under the Financing Agreement to receive and enforce repayment of its loan to the Company and to enforce payment of the Bonds, including all of the Authority's rights to the First Mortgage Bond, and all of the Authority's rights to moneys and securities in the Project Funds, the Revenue Funds and the Debt Service Funds (and the accounts within all such Funds applicable to the Bonds) established by the Trust Indenture, except for the Authority's rights to certain fees and reimbursements for expenses, indemnification and notice thereunder and rights relating to amendments of and notices under the Financing Agreement, will be assigned to the Trustee as security for the Bonds pursuant to the Trust Indenture.
(c) The Project will finance the acquisition, construction, installation and equipping of facilities for the furnishing of water for purposes of Section 142(a)(4) of the Internal Revenue Code of 1986, as amended (the "Code"), so that the interest on the Bonds will not be includable in gross income for federal income tax purposes under the Code and the Underwriter may offer the Bonds for sale without registration under the Securities Act of 1933, as amended (the "1933 Act) or qualification of the Trust Indenture under the Trust Indenture Act of 1939, as amended (the "1939 Act"). (d) A Preliminary Official Statement dated December 16, 2005, including the Appendices thereto and all documents incorporated therein by reference (the "Preliminary Official Statement"), has been supplied to the parties hereto, and a final Official Statement to be dated the date hereof, including the Appendices thereto and all documents incorporated therein by reference, prepared for use in such offerings will be supplied to the parties hereto as soon as it is available, subject to Section 10 hereof (such final Official Statement, as it may be amended or supplemented with the consent of the Authority, the Underwriter and the Company, is hereinafter referred to as the "Official Statement"). (e) The Bonds will be insured by a bond insurance policy (the "Bond Insurance Policy") issued by Financial Guaranty Insurance Company (the "Bond Insurer"). 2. PURCHASE, SALE AND CLOSING. On the terms and conditions herein set forth, the Underwriter will buy from the Authority, and the Authority will sell to the Underwriter, all (but not less than all) of the Bonds at a purchase price equal to $24,627,624, which is equal to the $24,675,000 aggregate principal amount of the Bonds, plus original issue premium of $322,749, less the underwriting discount of $370,125. Payment for the Bonds shall be made in immediately available funds to the Trustee for the account of the Authority. Closing (the "Closing") will be at the offices of Ballard Spahr Andrews & Ingersoll, LLP, Philadelphia, Pennsylvania, bond counsel, at 10:00 a.m., Eastern Daylight Time, on December 28, 2005 or at such other date, time or place or in such other manner as may be agreed on by the parties hereto. The Bonds will be delivered as one fully registered bond in the aggregate principal amount of $24,675,000 in the name of Cede & Co., as nominee for The Depository Trust Company ("DTC"), with CUSIP numbers printed thereon, and shall conform in all respects to DTC's Book-Entry Only System. Delivery of the Bonds to DTC will be made by delivering the Bonds to the Trustee utilizing the DTC FAST system. If the Underwriter so requests, the Bonds shall be made available to the Underwriter (prior to their delivery to DTC) in Philadelphia, Pennsylvania at least three full business days before the Closing for purposes of inspection. 2
The Underwriter agrees to make a bona fide public offering of the Bonds at the initial offering prices or yields set forth in the Official Statement; provided, however, that the Underwriter reserves the right (and the Authority and the Company hereby expressly acknowledge such right): to make concessions to dealers; to effect transactions that stabilize or maintain the market price of the Bonds above that which might otherwise prevail in the open market and to discontinue at any time such stabilizing transactions; and to change such initial offering prices, all as the Underwriter shall deem necessary in connection with the marketing of the Bonds. 3. AUTHORITY'S REPRESENTATIONS AND WARRANTIES. The Authority makes the following representations and warranties, all of which shall survive Closing; that: (a) The Authority is a body politic and corporate, duly created and existing under the Constitution and laws of the Commonwealth of Pennsylvania (the "Commonwealth"), and has, and at the date of Closing will have, full legal right, power and authority to: enter into this Bond Purchase Agreement; execute and deliver the Bonds, the Trust Indenture, the Financing Agreement, this Bond Purchase Agreement and the Authority's tax certificate and the other various certificates executed by the Authority in connection therewith (collectively, with the Authority Resolution, the "Authority Financing Documents"); issue, sell and deliver the Bonds to the Underwriter as provided herein; and carry out and consummate the transactions contemplated by the Authority Financing Documents and the Official Statement to be carried out and/or consummated by it; (b) The Authority Resolution was duly adopted at a public meeting of the Authority at which a quorum was present and acted throughout; and the Authority Resolution is in full force and effect and has not been amended, repealed or superseded in any way; (c) The sections entitled "INTRODUCTORY STATEMENT" (insofar as it relates to the Authority), "THE AUTHORITY" and "ABSENCE OF MATERIAL LITIGATION" (solely insofar as the information set forth therein relates to the Authority) contained in the Preliminary Official Statement as of its date did not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements contained therein, in the light of the circumstances under which they were made, not misleading; (d) The sections entitled "INTRODUCTORY STATEMENT" (insofar as it relates to the Authority), "THE AUTHORITY" and "ABSENCE OF MATERIAL LITIGATION" (solely insofar as the information set forth therein relates to the Authority) contained in the Official Statement as of its date does not or will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements contained therein, in the light of the circumstances under which they were made, not misleading; 3
(e) The Authority has complied, and will at the Closing be in compliance, in all material respects with the provisions of the Act; (f) The Authority has duly authorized and approved the Preliminary Official Statement and the Official Statement; and has duly authorized and approved the execution and delivery of, and the performance by the Authority of the obligations on its part contained in, the Authority Financing Documents; (g) To the best of the knowledge of the officer of the Authority executing this Bond Purchase Agreement, the Authority is not in material breach of or in default under any applicable law or administrative regulation of the Commonwealth or the United States; and the execution and delivery of the Authority Financing Documents, and compliance with the provisions of each thereof, do not and will not conflict with or constitute a breach of or default under any existing law, administrative regulation, judgment, decree, loan agreement, note, resolution, agreement or other instrument to which the Authority is a party or is otherwise subject; (h) All approvals, consents and orders of any governmental authority, board, agency or commission having jurisdiction that would constitute a condition precedent to the Authority's legal ability to issue the Bonds or to the Authority's performance of its obligations hereunder and under the Authority Financing Documents have been obtained or will be obtained prior to the Closing; (i) The Bonds, when issued, authenticated and delivered in accordance with the Trust Indenture and sold to the Underwriter as provided herein, will be validly issued and will be valid and binding limited obligations of the Authority enforceable against the Authority in accordance with their terms (except as enforcement of remedies may be limited by bankruptcy, insolvency, reorganization, moratorium or other laws or legal or equitable principles affecting the enforcement of creditors' rights ("Creditors' Rights Limitations")); (j) The terms and provisions of the Authority Financing Documents when executed and delivered by the respective parties thereto will constitute the valid, legal and binding obligations of the Authority enforceable against the Authority in accordance with their respective terms (except as enforcement of remedies may be limited by Creditors' Rights Limitations); (k) There is no action, suit, proceeding, inquiry or investigation, at law or in equity, before or by any court, or public board or body, pending or, to the knowledge of the Authority after due inquiry, threatened against the Authority, affecting the existence of the Authority or the titles of its officers to their respective offices or seeking to prohibit, restrain or enjoin the sale, issuance or delivery of the Bonds or of the revenues or assets of the Authority pledged or to be pledged to pay the principal of and interest on the Bonds, or the pledge thereof, or in any way contesting or affecting the validity or enforceability of the Authority Financing Documents or contesting in any way the completeness or accuracy of the Preliminary Official Statement or the Official Statement, or contesting the power or authority of the Authority with respect to the issuance of the Bonds or the execution, delivery or performance of any of the Authority Financing Documents, wherein an unfavorable decision, ruling or finding would affect in any way the validity or enforceability of any of the Authority Financing Documents; 4
(l) The net proceeds received from the Bonds and applied in accordance with the Trust Indenture and Financing Agreement shall be used in accordance with the Act as described in the Official Statement; (m) The Authority has not been notified of any listing or proposed listing by the Internal Revenue Service to the effect that the Authority is a bond issuer whose arbitrage certifications may not be relied upon; and (n) Any certificate signed by any of the authorized officers of the Authority and delivered to the Underwriter shall be deemed a representation and warranty by the Authority to the Underwriter as to the statements made therein. 4. COMPANY'S REPRESENTATIONS AND WARRANTIES. The Company makes the following representations and warranties on and as of the date hereof and as of the date of Closing, all of which will survive the Closing: (a) The Company has not sustained since December 31, 2004 any material loss or interference with its business from fire, explosion, flood or other calamity, whether or not covered by insurance, or from any labor dispute or court or governmental action, order or decree; and since the respective dates as of which information is given in the Official Statement, there have not been any material changes in the outstanding capital stock or the long-term debt of the Company or any material adverse change, or a development involving a prospective material adverse change, in or affecting the general affairs, management, financial position, stockholders' equity or results of operations of the Company, otherwise than as set forth or contemplated in the Official Statement; (b) The Company was organized, is in good standing and subsists as a corporation under the laws of the Commonwealth, with power (corporate and other) to own its properties and conduct its business as described in the Official Statement; (c) The First Mortgage Bond has been duly authorized; and, when issued and delivered as contemplated by this Bond Purchase Agreement, will have been duly executed, authenticated, issued and delivered and will constitute a valid and legally binding obligation of the Company entitled to the benefits provided by the Mortgage; (d) The Original Indenture has been duly authorized, executed and delivered by the Company, and the Fortieth Supplemental Mortgage has been duly authorized by the Company. When the Fortieth Supplemental Mortgage, in substantially the form approved by the Company, has been executed and delivered by the Company and assuming due authorization and execution by the Mortgage Trustee, and recorded as required by law, the Mortgage will constitute a valid and legally binding instrument enforceable against the Company in accordance with its terms except as enforceability may be limited by Creditors' Rights Limitations; will constitute a direct, valid and enforceable first mortgage lien (except as enforceability of such lien may be limited by Creditors' Rights Limitations) upon all of the properties and assets of the Company (not heretofore released as provided for in the Mortgage) specifically or generally described or referred to in the Mortgage as being subject to the lien thereof, excepting permitted liens under the Mortgage and excepting property and assets that the Mortgage expressly excludes from the lien thereof; and will create a mortgage upon all properties and assets acquired by the Company after the execution and delivery of the Fortieth Supplemental Mortgage and required to be subjected to the lien of the Mortgage pursuant thereto when so acquired, except for permitted liens under the Mortgage. The Original Indenture has been and the Fortieth Supplemental Mortgage will be duly filed, recorded or registered in each place in the Commonwealth in which such filing, recording or registration was or is required to protect and preserve the lien of the Mortgage; and all necessary approvals of regulatory authorities, commissions and other governmental bodies having jurisdiction over the Company required to subject the mortgaged properties and assets or trust estate (as defined in the Mortgage) to the lien of the Mortgage have been duly obtained; 5
(e) In each of the following cases with such exceptions as are not material and do not interfere with the conduct of the business of the Company, the Company has good and marketable title to all of its real property currently held in fee simple; and all of its other interests in real property (other than certain rights of way, easements, occupancy rights, riparian and flowage rights, licenses, leaseholds, and real property interests of a similar nature). In each case such title is free and clear of all liens, encumbrances and defects except such as may be described in the Official Statement, the lien of the Mortgage, permitted liens under the Mortgage or such as do not materially affect the value of such property and do not interfere with the use made and proposed to be made of such property by the Company. Any real property and buildings held under lease by the Company are held by it under valid, subsisting and enforceable leases with such exceptions as are not material and do not interfere with the use made and proposed to be made of such property and buildings by the Company; (f) In each of the following cases except for such exceptions that are not material and do not interfere with the conduct of the business of the Company, the Company has all licenses, franchises, permits, authorizations, rights, approvals, consents and orders of all governmental authorities or agencies necessary for the ownership or lease of the properties owned or leased by it and for the operation of the business carried on by it as described in the Official Statement, and all water rights, riparian rights, easements, rights of way and other similar interests and rights described or referred to in the Mortgage necessary for the operation of the business carried on by it as described in the Official Statement. Except as otherwise set forth in the Official Statement, all such licenses, franchises, permits, orders, authorizations, rights, approvals and consents are in full force and effect and contain no unduly burdensome provisions; except as otherwise set forth in the Official Statement, there are no legal or governmental proceedings pending or, to its knowledge after due inquiry, threatened that would result in a material modification, suspension or revocation thereof. The Company has the legal power to exercise the rights of eminent domain for the purposes of conducting its water utility operations; (g) The issue and sale of the Bonds, the issue and delivery of the First Mortgage Bond and the compliance by the Company with all of the applicable provisions of the First Mortgage Bond and the Mortgage and the execution, delivery and performance by the Company of the Fortieth Supplemental Mortgage, the Financing Agreement, this Bond Purchase Agreement and the Continuing Disclosure Agreement will not conflict with or result in a breach of any of the terms or provisions of, or constitute a default under, or result in the creation or imposition of any lien, charge or encumbrance (other than the lien of the Mortgage) upon any of the property or assets of the Company pursuant to the terms of any indenture, mortgage, deed of trust, loan agreement or other agreement or instrument to which the Company is a party or by which the Company is bound or to which any of the property or assets of the Company are subject, nor will such action result in a violation of the provisions of the Articles of Incorporation, as amended, or the Bylaws of the Company or any statute or any order, rule or regulation of any court or governmental agency or body having jurisdiction over the Company or any of its property. No consent, approval, authorization, order, registration or qualification of or with any court or any such regulatory authority or other governmental body (other than those already obtained) is required to be obtained by the Company for the issue and sale of the Bonds, the issue and delivery of the First Mortgage Bond, the execution, delivery and performance by the Company of this Bond Purchase Agreement, the Financing Agreement, the Fortieth Supplemental Mortgage, the First Mortgage Bond and the Continuing Disclosure Agreement, or the consummation by the Company of the other transactions contemplated by this Bond Purchase Agreement or the Mortgage; 6
(h) The Pennsylvania Public Utility Commission by order has duly authorized the issuance and delivery of the First Mortgage Bond on terms not inconsistent with this Bond Purchase Agreement; (i) The Company is not a holding company, a registered holding company or an affiliate of a registered holding company within the meaning of the Public Utility Holding Company Act of 1935, as amended; (j) There are no legal or governmental proceedings pending to which the Company is a party or to which any property of the Company is subject, other than as set forth in the Official Statement and other than litigation incident to the kind of business conducted by the Company, wherein an unfavorable ruling, decision or finding is likely that would have a material adverse effect on the financial position, stockholders' equity or results of operations of the Company; and, to the best of the Company's knowledge after due diligence, no such proceedings are threatened by governmental authorities or threatened by others; (k) The Project consists of either land or property of a character subject to depreciation for federal income tax purposes and will be used to furnish water that is or will be made available to members of the general public (including electric utility, industrial, agricultural, or commercial users); the rates for the furnishing or sale of the water have been established or approved by a State or political subdivision thereof, by an agency or instrumentality of the United States, or by a public service or public utility commission or other similar body of any State or political subdivision thereof; and all other information supplied by the Company to the Underwriter with respect to the exclusion from gross income pursuant to Section 103 of the Code of the interest on the Bonds is correct and complete; (l) The Company has not, within the immediately preceding ten (10) years, defaulted in the payment of principal or interest on any of its bonds, notes or other securities, or any legally authorized obligation issued by it; and 7
(m) The information with respect to the Company and the Project and the descriptions of the First Mortgage Bond and the Mortgage contained in the Preliminary Official Statement and the Official Statement (including appendices A and B thereto) do not contain an untrue statement of a material fact or omit to state a material fact necessary to make such information and descriptions, in the light of the circumstances under which they were made, not misleading. 5. AUTHORITY'S COVENANTS. The Authority will: (a) furnish such information, execute such instruments and take such other action in cooperation with the Underwriter as the Underwriter may reasonably request to qualify the Bonds for offer and sale under the Blue Sky or other securities laws and regulations of such states and other jurisdictions in the United States of America as the Underwriter may designate and will assist, if necessary therefor, in the continuance of such qualifications in effect so long as required for distribution of the Bonds; provided, however, that the Authority shall in no event be required to file a general consent to suit or service of process or to qualify as a foreign corporation or as a dealer in securities in any such state or other jurisdiction; (b) not, on its part, amend or supplement the Official Statement without prior notice to and the consent of the Underwriter and the Company and will advise the Underwriter and the Company promptly of the institution of any proceedings by any governmental agency or otherwise affecting the use of the Official Statement in connection with the offer and sale of the Bonds; and (c) refrain from knowingly taking any action (and permitting any action with regard to which the Authority may exercise control) which would result in the loss of the exclusion from gross income for federal income tax purposes of interest on the Bonds referred to under the caption "TAX MATTERS" in the Official Statement. 6. COMPANY'S COVENANTS. The Company agrees that it will: (a) refrain from knowingly taking any actions (and from permitting any action with regard to which the Company may exercise control) that would result in the loss of the exclusion from gross income for federal tax purposes of interest on the Bonds; (b) indemnify and hold harmless the Authority, its members, directors, officers, agents, attorneys, and employees and the Underwriter, its officers, directors, officials, agents, attorneys, employees, and each person, if any, who controls the Underwriter within the meaning of Section 15 of the 1933 Act or Section 20 of the Securities Exchange Act of 1934, as amended (the "1934 Act"), from and against all losses, claims, damages, liabilities and expenses, joint or several, to which the Authority and the Underwriter, or either of them, or any of their respective members, directors, officers, agents, attorneys, and employees and each person, if any, who controls the Underwriter within the meaning of the 1933 Act or 1934 Act as aforedescribed may become subject, under federal laws or regulations, or otherwise, insofar as such losses, claims, damages, liabilities and expenses (or actions in respect thereof) arise out of or are based upon: a breach of the Company's representations included in this Agreement; any untrue statement or alleged untrue statement of any material fact pertaining to the Project or the Company set forth in the Official Statement, the Preliminary Official Statement or any amendment to either; or the willful or negligent omission of (or the alleged omission to state) a material fact in the Official Statement, in the Preliminary Official Statement, or in any amendment or supplement to either, as such fact is required to be stated therein or necessary to make the statements therein that pertain to the Company or the Project not misleading in the light of the circumstances under which they were made; or (iv) arising by virtue of the failure to register the Bonds under the 1933 Act or the failure to qualify the Indenture under the 1939 Act; or (v) arising by virtue of any audit or investigation conducted by a state or federal agency, department or entity questioning, among other things, the tax-exempt status of the Bonds; 8
(c) undertake, pursuant to the Continuing Disclosure Agreement dated as of December 15, 2005 to be entered into between the Company and the Trustee (the "Continuing Disclosure Agreement"), to provide annual reports and notices of certain material events in accordance with Rule 15c2-12 under the 1934 Act, as amended ("Rule 15c2-12"). A description of this undertaking and the Continuing Disclosure Agreement is set forth in the Preliminary Official Statement and will also be set forth in the Final Official Statement; and (d) not amend or supplement the Official Statement without prior notice to, and the consent of, the Underwriter, and will advise the Underwriter and the Authority promptly of the institution of any proceedings by any governmental agency or otherwise affecting the use of the Official Statement in connection with the offer and the sale of the Bonds. 7. UNDERWRITER'S COVENANT AND REPRESENTATIONS AND WARRANTIES. (a) By acceptance hereof the Underwriter agrees to indemnify and hold harmless the Authority, its members, directors, officers, agents, attorneys, and employees and the Company, its officers, directors, agents, attorneys, and employees and each person if any, who controls the Company within the meaning of Section 15 of the 1933 Act against all or several claims, losses, damages, liabilities and expenses asserted against them, or any of them, at law or in equity, in connection with the offering and sale of the Bonds on the grounds that the information under the caption "UNDERWRITING" in the Preliminary Official Statement or the Official Statement (or any supplement or amendment to said information) contains an untrue or allegedly untrue statement of a material fact or omits or allegedly omits to state any material fact necessary to make the statements therein not misleading in the light of the circumstances under which they were made (it being understood that the Underwriter furnished only the information under such "UNDERWRITING" heading), or failure on the part of the Underwriter to deliver an Official Statement to any purchaser. The Underwriter will reimburse any legal or other expenses reasonably incurred by a party, person or entity indemnifiable under this Section 7 in connection with investigating or defending any such loss, claim, damage, liability or action. This indemnity agreement will be in addition to any liability that the Underwriter may otherwise have. The Underwriter shall not be liable for any settlement of, any such action effected without its consent. (b) The Underwriter will be paid an underwriting discount of $370,125 with respect to the Bonds. 9
(c) The Underwriter acknowledges that the Authority is relying upon the veracity of the certification in clause (b) above on the date hereof as a condition precedent to lending the proceeds of the Bonds to the Company. 8. NOTICE OF INDEMNIFICATION; SETTLEMENT. Promptly after a party, person or entity indemnifiable under Section 6 or 7 of this Bond Purchase Agreement (an "Indemnitee") receives notice of the commencement of any audit, investigation or action against such Indemnitee in respect of which indemnity is to be sought by the Indemnitee against the Company or an Underwriter, as the case may be (the "Indemnifying Party"), the Indemnitee will notify the Indemnifying Party in writing of such action, and the Indemnifying Party may assume the defense thereof, including the employment of counsel and the payment of all expenses; but the omission so to notify the Indemnifying Party will not relieve the Indemnifying Party from any liability that it may have to the Indemnitee otherwise than hereunder. The Indemnifying Party shall not be liable for any settlement of any such action effected without its consent, but if settled with the consent of the Indemnifying Party or if there is a final judgment for the plaintiff in any such action, the Indemnifying Party will indemnify and hold harmless the Indemnitee from and against any loss or liability by reason of such settlement or judgment. The indemnity agreements contained in this Bond Purchase Agreement shall include reimbursement for expenses reasonably incurred by an Indemnitee in investigating the claim and in defending it if the Indemnifying Party declines to assume the defense and shall survive delivery of the Bonds. Notwithstanding the foregoing, in the event of an investigation or audit by the Internal Revenue Service or the Securities and Exchange Commission or any other state or federal agency, department, or entity with respect to the Bonds, the Authority shall have the right and duty to undertake its own defense, including the employment of counsel, with full power to litigate, compromise or settle the same on its own behalf, and the Company agrees that it will indemnify and hold the Authority harmless for all costs and expenses, including, but not limited to, attorney fees and expenses and costs, of any such settlement. 9. EQUITABLE CONTRIBUTION. If the indemnification provided for in Section 6(b) of this Bond Purchase Agreement is unavailable to the Underwriter (or any controlling person thereof) in respect of any losses, claims, damages or liabilities referred to therein, then the Company shall, in lieu of indemnifying the Underwriter, contribute to the amount paid or payable by the Underwriter as a result of such losses, claims, damages or liabilities in such proportion as is appropriate to reflect the relative benefits received by the Company and the Underwriter, respectively, from the offering of the Bonds. If, however, the allocation provided by the immediately preceding sentence is not permitted by applicable law, then the Company shall contribute to such amount paid or payable by the Underwriter in such proportion as is appropriate to reflect not only such relative benefits but also the relative fault of the Company and the Underwriter, respectively, in connection with the statements or omission which resulted in such losses, claims, damages or liabilities, as well as any other relevant equitable considerations. The relative benefit received by the Company or the Underwriter shall be deemed to be in the same proportion as the total proceeds from the offering (before deducting issuance costs and expenses other than underwriting fees and commissions) received by the Company, on the one hand, bear to the total underwriting fees and commissions received by the Underwriter, on the other hand. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact related to information supplied by the Company or the Underwriter and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and the Underwriter agree that it would not be just and equitable if contribution pursuant to this Section 9 were determined by pro rata allocation or by any other method of allocation that does not take account of the equitable considerations referred to above in this Section 9. The amount paid or payable by the Underwriter as a result of the losses, claims, damages or liabilities referred to above in this Section 9 shall be deemed to include any reasonable legal or other expenses reasonably incurred by the Underwriter in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this Section 9, the Underwriter shall not be required to contribute any amount in excess of the amount by which the total price at which the Bonds underwritten by it and distributed to the public were offered to the public exceeds the amount of any damages that the Underwriter has otherwise been required to pay by reason of such untrue or allegedly untrue statement or omission or alleged omission. 10
10. OFFICIAL STATEMENT; PUBLIC OFFERING. (a) In order to enable the Underwriter to comply with Rule 15c2-12: the Company has prepared (or caused to be prepared) the Preliminary Official Statement, which the Company and the Authority (but, in the case of the Authority, only with respect to the information therein under the headings "THE AUTHORITY" and, insofar as they relate to the Authority, "INTRODUCTORY STATEMENT" and "ABSENCE OF MATERIAL LITIGATION") deem final and complete as of its date except for certain "Permitted Omissions" as described in Rule 15c2-12; the Company shall provide to the Underwriter sufficient copies of the Official Statement in sufficient time to accompany any confirmation that requires payment from any customer and in any event within seven business days after the date of this Bond Purchase Agreement; and of which the Company has or gains knowledge would render the Official Statement misleading in any material respect in the period from the date of its delivery to the Underwriter by the Company (as that phrase is defined in Rule 15c2-12) then the Company shall promptly give the Underwriter notice thereof. The Authority and the Company hereby authorize the use of the Preliminary Official Statement and the Official Statement by the Underwriter in connection with the offering of the Bonds. (b) After the Closing, and until the Underwriter has informed the Authority and the Company that the Underwriter has sold all the Bonds, the Authority and the Company will not adopt or distribute any amendment of or supplement to the Official Statement, except with the prior written consent of the Underwriter; and if any event relating to or affecting the Authority, the Company or the Bonds shall occur, the result of which shall make it necessary, in the opinion of the Underwriter, to amend or supplement the Official Statement in order to make it not misleading in the light of the circumstances existing at that time, the Company shall forthwith prepare, and the Company and the Authority shall approve for distribution, a reasonable number of copies of an amendment of or supplement to the Official Statement, in form and substance reasonably satisfactory to the Underwriter, so that the Official Statement then will not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements therein, in the light of the circumstances existing at that time, not misleading. The Authority shall cooperate with the Company in the issuance and distribution of any such amendment or supplement. (c) Upon Closing, the Underwriter shall promptly provide a Nationally Recognized Municipal Securities Information Repository ("NRMSIR") and the Municipal Securities Rulemaking Board ("MSRB") with a copy of the Official Statement for filing in accordance with Rule 15c2-12, and inform the Authority and the Company in writing as to the date and place of such filing and the date of the end of the underwriting period. 11
11. CONDITIONS OF UNDERWRITER'S AND AUTHORITY'S OBLIGATIONS. The Underwriter's obligations to purchase and pay for the Bonds and the Authority's obligation to issue and deliver the Bonds are subject to fulfillment of the following conditions at or before Closing: (a) The representations of the Authority and the Company herein shall be true in all material respects on and as of the date of the Closing and shall be confirmed by appropriate certificates at Closing; (b) Neither the Authority nor the Company shall be in default in the performance of any of their respective covenants herein; (c) The Underwriter shall have received: (i) An opinion of Ballard Spahr Andrews & Ingersoll, LLP, Bond Counsel, dated the date of Closing, substantially in the form attached as Exhibit A hereto, addressed to (or with reliance letters delivered in respect of) the Authority, the Trustee and the Underwriter; (ii) An opinion of Ballard Spahr Andrews & Ingersoll, LLP, Bond Counsel, dated the date of Closing, substantially in the form attached as Exhibit B hereto, addressed to the Underwriter; (iii) An opinion of Blank Rome LLP, counsel for the Authority, dated the date of Closing, substantially in the form attached as Exhibit C hereto, addressed to the Underwriter and in form and substance reasonably satisfactory to the Underwriter and Bond Counsel; (iv) Opinions of Dilworth Paxson LLP, counsel to the Company, and the Company's Senior Vice President - Law and Administration, dated the date of Closing, substantially in the forms attached as Exhibit D hereto, addressed to the Underwriter, the Authority and Bond Counsel, in form and substance reasonably satisfactory to the Underwriter and to Bond Counsel; (v) An opinion of Saul Ewing LLP, counsel for the Underwriter, in form and substance reasonably satisfactory to the Underwriter; (vi) An opinion of legal counsel to the Bond Insurer in form and substance reasonably satisfactory to Bond Counsel and the Underwriter, relating to the enforceability of the Bond Insurance Policy and the information concerning the Bond Insurer in the Official Statement; 12
(vii) An agreed upon procedures letter dated the date of the Official Statement and addressed to the Company from the Company's auditor with respect to financial information set forth in Appendix A to the Official Statement, in form and substance reasonably satisfactory to the Company's auditor and the Underwriter; (viii) A certificate dated the date of Closing executed by the Chairman of the Authority to the effect that: (A) the representations and warranties of the Authority contained herein, to the best of the knowledge of such Chairman, are true and correct in all material respects as of the date of Closing; and (B) to the best of the knowledge of such Chairman, the Authority has complied in all material respects with all agreements executed by the Authority in connection with issuance of the Bonds and satisfied in all material respects the Authority's covenants contained in Section 5 herein and all of the conditions on its part to be performed or satisfied at or prior to the Closing; (ix) A certificate dated the date of Closing executed by the chief financial officer of the Company to the effect that: (A) the representations and warranties of the Company in this Bond Purchase Agreement are true and correct in all material respects as of the date of Closing; (B) the Preliminary Official Statement and the Official Statement, as of their respective dates, insofar as they relate to the Company, do not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, under the circumstances in which they were made, not misleading in any respect; and (C) no event affecting the Company has occurred since the date of the Bond Purchase Agreement that is required to be disclosed in the Official Statement in order to make the statements and information therein not misleading in any material respect; (x) Two executed copies of the Trust Indenture, the Financing Agreement, the Bond Purchase Agreement, the Fortieth Supplemental Mortgage and the Continuing Disclosure Agreement and specimen copies of the First Mortgage Bond; (xi) Two copies of the Articles of Incorporation and By-laws of the Company, as amended to the date of Closing, and of the resolutions of the Board of Directors of the Company authorizing and approving the execution and delivery of this Bond Purchase Agreement, the Financing Agreement, the First Mortgage Bond, the Fortieth Supplemental Mortgage, the Continuing Disclosure Agreement and the incurrence of indebtedness with respect thereto and all transactions described in the Official Statement and contemplated by this Bond Purchase Agreement, all certified by its Secretary or Assistant Secretary; 13
(xii) Two copies of the Authority Resolution; (xiii) One or more letters from the Company's auditor, dated the date of the Preliminary Official Statement and the Official Statement and addressed to the Company, consenting to the use of the financial statements prepared by such firm and all references to such firm contained in the Preliminary Official Statement and the Official Statement; (xiv) Evidence of the issuance of the Bond Insurance Policy by the Bond Insurer, which policy shall unconditionally and irrevocably guarantee the payment when due of the principal of and interest on the Bonds; (xv) Evidence satisfactory to the Underwriter of a rating of "AAA" assigned by Standard & Poor's Ratings Services, a Division of The McGraw-Hill Companies, and that such rating is in full force and effect as of the date of Closing; (xvi) Evidence satisfactory to Bond Counsel and the Underwriter of the receipt by the Authority of a Preliminary Allocation relating to the Bonds from the Pennsylvania Department of Community and Economic Development and of the registration of a Securities Certificate relating to the First Mortgage Bond and the Bonds with the Pennsylvania Public Utility Commission; and (xvii) Such additional documentation as the Underwriter or its counsel or Bond Counsel may reasonably request to evidence compliance with applicable law and the validity of the Bonds, the Financing Agreement, the Trust Indenture, this Bond Purchase Agreement, the Mortgage, the First Mortgage Bond and the Continuing Disclosure Agreement, and to evidence that the interest on the Bonds is not includable in gross income under the Code and the status of the offering under the 1933 Act and the 1939 Act; (d) At Closing there shall not have been any material adverse change in the financial condition of the Company or any adverse development concerning the business or assets of the Company that would result in a material adverse change in the prospective financial condition or results of operations of the Company from that described in the Official Statement, which, in the judgment of the Underwriter, makes it inadvisable to proceed with the sale of the Bonds; and the Underwriter shall have received certificates of the Company certifying that no such material adverse change has occurred or, if such a change has occurred, full information with respect thereto; and (e) The Underwriter shall deliver at Closing a certificate in form acceptable to Bond Counsel to the effect that the Underwriter has sold to the public (excluding bond houses and brokers) a substantial amount of the Bonds at initial offering prices no higher than, or yields no lower than, those shown on the cover page of the Official Statement and that such certificate may be relied upon for purposes of determining compliance with Section 148 of the Code. 14
12. EVENTS PERMITTING THE UNDERWRITER TO TERMINATE. The Underwriter may terminate its obligation to purchase the Bonds at any time before Closing if any of the following occurs: (a) A legislative, executive or regulatory action or proposed action, or a court decision, which in the reasonable judgment of the Underwriter casts sufficient doubt on the legality of, or the exclusion from gross income for federal income tax purposes of interest on, obligations such as the Bonds so as to materially impair the marketability or materially lower the market price of the Bonds; or (b) Any action by the Securities and Exchange Commission or a court that would require registration of the Bonds or the First Mortgage Bond under the 1933 Act or qualification of the Indenture under the 1939 Act; or (c) Any general suspension of trading in securities on the New York Stock Exchange or the establishment, by the New York Stock Exchange, by the Securities and Exchange Commission, by any federal or state agency, or by the decision of any court, of any limitation on prices for such trading, or any outbreak of hostilities or other national or international calamity or crisis, or any material escalation in any such hostilities, calamity or crisis, the effect of which on the financial markets of the United States of America shall be such as to materially impair the marketability or materially lower the market price of the Bonds; or (d) Any event or condition occurring or arising after the date hereof, which in the reasonable judgment of the Underwriter renders untrue or incorrect, in any material respect as of the time to which the same purports to relate, the information contained in the Official Statement, or which requires that information not reflected in the Official Statement or Appendices thereto should be reflected therein in order to make the statements and information contained therein not misleading in any material respect as of such time; provided that the Authority, the Company and the Underwriter will use their best efforts to amend or supplement the Official Statement to reflect, to the reasonable satisfaction of the Underwriter, such changes in or additions to the information contained in the Official Statement; or (e) Pending or threatened litigation affecting or arising out of the ownership of the Facilities or any other facilities of the Company or the issuance of the Bonds, which, in the reasonable judgment of the Underwriter, would materially impair the marketability or materially lower the market price of the Bonds; or (f) Quantities of the Official Statement are not delivered to the Underwriter in a timely manner as required by Section 10 hereof. If the Underwriter terminates its obligation to purchase the Bonds because any of the conditions specified in Section 11 hereof or this Section 12 shall not have been fulfilled at or before the Closing, such termination shall not result in any liability on the part of the Authority, the Underwriter, or, except for the payment of such costs of issuance described in Section 13 hereof which are due and payable, the Company. 15
13. EXPENSES. All expenses and costs of the authorization, issuance, sale and delivery of the Bonds including, without limitation, accrued interest, the preparation of and furnishing to the Underwriter of the Preliminary Official Statement and the Official Statement, the preparation and execution of the Bonds, the Financing Agreement, the Trust Indenture, the First Mortgage Bond, the Fortieth Supplemental Mortgage, the Continuing Disclosure Agreement and this Bond Purchase Agreement, the Insurance Policy premium, rating agency fees, the issuance and closing fees of the Authority, the fees and disbursements of counsel to the Authority, the fees and disbursements of Bond Counsel, the fees and disbursements of counsel to the Underwriter and the expenses incurred in connection with qualifying the Bonds for sale under the securities laws of various jurisdictions and preparing Blue Sky and legal investment memoranda, shall be paid by the Company from funds contributed by the Company and from proceeds of the Bonds. The Authority shall, bear no out-of-pocket expense in connection with the transactions contemplated by this Bond Purchase Agreement. The Underwriter will pay all other expenses of the Underwriter in connection with the public offering of the Bonds. 14. EXECUTION IN COUNTERPARTS. This Bond Purchase Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument, and any of the parties hereto may execute this Bond Purchase Agreement by signing any such counterpart. 15. NOTICES AND OTHER ACTIONS. All notices, requests, demands and formal actions hereunder will be in writing mailed, faxed (with confirmation of receipt) or delivered by nationally recognized, next-day delivery service to: The Underwriter: Sovereign Securities Corporation, LLC Mail Code: 20-210-CPC LLC 1500 Market Street Centre Square-Concourse Philadelphia, Pennsylvania 19102 Attention: George C. Werner, III Managing Director Fax #: (267) 675-0643 Email: gwerner@sovereignbank.com The Company: Aqua Pennsylvania, Inc. 762 Lancaster Avenue Bryn Mawr, Pennsylvania 19010 Attention: Kathy Lee Pape, Vice President, Treasurer & Rate Counsel Fax #: (610) 519-0989 Email: klpape@aquaamerica.com The Authority: Delaware County Industrial Development Authority 200 East State Street, Suite 205 Media, Pennsylvania 19063 Attention: J. Patrick Killian, Commerce Director Fax #: (610) 566-7337 Email: info@delcopa.org 16
16. GOVERNING LAW. This Bond Purchase Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Pennsylvania, excluding those relating to choice of laws or conflict of laws, and may not be assigned by the Authority, the Company or the Underwriter. 17. SUCCESSORS. This Bond Purchase Agreement will inure to the benefit of and be binding upon the parties and their respective successors and, as to Sections 6, 7 and 8 hereof, the Indemnitees, and will not confer any rights upon any other person. The term "successor" shall not include any holder of any Bonds merely by virtue of such holding. 18. LIMITATIONS ON LIABILITY. No personal recourse shall be had for any claim based on this Bond Purchase Agreement or the Bonds against any board member, officer, agent, employee, or attorney past, present or future, of the Authority or any successor body as such, either directly or through the Authority or any successor body, under any constitutional provision, statute, or rule of law or by enforcement of any assessment or penalty or otherwise. Notwithstanding any provision or obligation to the contrary in this Bond Purchase Agreement, the liability of the Authority for payments of any kind, nature or description provided for herein or in any other document executed pursuant hereto shall be limited to the revenues derived by the Authority from the Financing Agreement. 17
IN WITNESS WHEREOF, the Authority, the Company and the Underwriter have caused their duly authorized Underwriters to execute and deliver this Bond Purchase Agreement as of the date first written above. DELAWARE COUNTY INDUSTRIAL DEVELOPMENT AUTHORITY By: /s/ Henry Coleman ------------------------------------------- Chairman AQUA PENNSYLVANIA , INC. By: /s/ Kathy L. Pape ------------------------------------------- Vice President, Treasurer and Rate Counsel SOVEREIGN SECURITIES CORPORATION, LLC By: /s/ George C. Werner, III ------------------------------------------- George C. Werner, III Managing Director
SCHEDULE I Terms of Bonds Dated Date: December 22, 2005 Series Maturity Date Principal Amount Rate of Interest Yield - ------ ------------- ---------------- ---------------- ------ C February 1, 2035 $24,675,000 5.00% 4.820% Interest Payment Dates: February 1 and August 1, commencing February 1, 2006 Redemption Provisions: The Bonds are subject to redemption as follows: OPTIONAL REDEMPTION. The Bonds are subject to optional redemption prior to maturity by the Authority, at the direction of the Company, on or after February 1, 2015, as a whole or in part at any time, at a redemption price equal to one hundred percent (100%) of the principal amount thereof, plus interest accrued to the date fixed for redemption. EXTRAORDINARY OPTIONAL REDEMPTION. The Bonds are subject to redemption, at any time prior to maturity, at the option of the Authority, upon the direction of the Company, in whole, at a Redemption Price of 100% of the principal amount of the Bonds to be redeemed, plus interest accrued thereon to the date fixed for redemption, if any of the following events shall have occurred: (a) The damage or destruction of all or substantially all of the Facilities to such extent, that, in the reasonable opinion of the Company, the repair and restoration thereof would not be economical; or (b) the taking by condemnation, or the threat thereof, of all or substantially all of the Facilities or the taking by condemnation of any part, use or control of the Facilities so as to render them unsatisfactory to the Company for their intended use; or (c) in the Company's reasonable opinion, (1) unreasonable burdens or excessive liabilities shall have been imposed upon the Company with respect to the Facilities or the operation thereof, including, but not limited to, federal, state or other ad valorem, property, income or other taxes not being imposed on the date of the Agreement other than ad valorem property taxes presently levied upon privately owned property used for the same general purposes as the Facilities, or (2) the continued operation of the Facilities is impractical, uneconomical or undesirable for any reason. Schedule 1-I
Any such redemption shall be on any date within 180 days following the occurrence of one of the events listed above permitting the exercise of the option. SPECIAL MANDATORY REDEMPTION. The Bonds are subject to mandatory redemption, in part, on the first interest payment date for which notice can be given in accordance with the Trust Indenture after the Project has been completed and the certificate of the Company with respect thereto required by the Financing Agreement has been filed with the Authority and the Trustee, to the extent of any amounts transferred from the Project Fund to the Debt Service Fund pursuant to the Trust Indenture, at a Redemption Price of 100% of the principal amount of the Bonds to be redeemed, plus accrued interest thereon to the date fixed for redemption. Schedule 1-I
EXHIBIT A FORM OF APPROVING OPINION OF BALLARD SPAHR ANDREWS & INGERSOLL, LLP Upon delivery of the Bonds, Ballard Spahr Andrews & Ingersoll, LLP, Philadelphia, Pennsylvania, Bond Counsel, will issue its approving opinion in substantially the following form: December 28, 2005 Delaware County Industrial Development Authority Wachovia Bank, National Association, as Trustee 200 East State Street, Suite 205 123 South Broad Street Media, Pennsylvania 19063 Philadelphia, Pennsylvania 19109 Sovereign Securities Corporation, LLC Aqua Pennsylvania, Inc. 1500 Market Street 762 Lancaster Avenue Centre Square - Concourse Bryn Mawr, Pennsylvania 19010 Philadelphia, Pennsylvania 19102 Re: $24,675,000 aggregate principal amount of Delaware County Industrial Development Authority Water Facilities Revenue Bonds (Aqua Pennsylvania, Inc. Project) Series C of 2005 -------------------------------------------------- Ladies and Gentlemen: We have acted as Bond Counsel to the Delaware County Industrial Development Authority (the "Authority") in connection with the issuance and sale of its $24,675,000 aggregate principal amount of Delaware County Industrial Development Authority Water Facilities Revenue Bonds (Aqua Pennsylvania, Inc. Project) Series C of 2005 (the "Bonds"). The Bonds are being issued by the Authority at the request of Aqua Pennsylvania, Inc., as successor to Philadelphia Suburban Water Company (the "Company"), to finance facilities located in the Pennsylvania Counties of Chester, Delaware and Montgomery (the "Project Facilities") for the furnishing of water which is made available on reasonable demand to members of the general public in portions of the Pennsylvania Counties of Chester, Delaware and Montgomery. The Bonds are issuable in fully registered form, and are being issued under the Trust Indenture dated as of December 15, 2005 (the "Indenture") between the Authority and Wachovia Bank, National Association, as trustee (the "Trustee"). The Authority and the Company are entering into a Financing Agreement dated as of December 15, 2005 (the "Financing Agreement"), pursuant to which the Authority will lend the proceeds of the Bonds to the Company to finance the Project Facilities. In satisfaction of its obligation under the Financing Agreement with respect to the Bonds, the Company, concurrently with the issuance of the Bonds, is delivering to the Trustee its First Mortgage Bond, 5.00% Series C due 2035 (the "First Mortgage Bond") in the principal amount equal to the principal amount of the Bonds. The Authority has assigned its interests under the Financing Agreement with respect to the Bonds, including its right to receive the First Mortgage Bond and the payments thereunder, to the Trustee for the benefit of the holders of the Bonds. A-1
The Internal Revenue Code of 1986, as amended (the "Code") establishes certain requirements which must be met on a continuing basis subsequent to the issuance and delivery of the Bonds for interest on the Bonds to be excluded from the gross income of the holders thereof for federal income tax purposes. For the purposes of the opinion set forth below, we have relied on representations of the Authority and the Company with respect to the application of the proceeds of the Bonds, the nature of the Project Facilities and other matters solely within the knowledge of the Authority and the Company which we have not independently verified, and have assumed continuing compliance with the covenants in the Indenture, the Financing Agreement and the certificates of the Company with respect to the Project Facilities delivered at closing pertaining to the requirements of those sections of the Code which affect the exclusion from gross income of interest on the Bonds for federal income tax purposes. In the event that such representations are determined to be inaccurate or incomplete or the Authority or the Company fails to comply with the aforementioned covenants, interest on the Bonds could become includable in gross income from the date of issuance, regardless of the date on which the event causing such inclusion occurs. In our capacity as Bond Counsel, we have examined such documents, records of the Authority and other instruments as we deemed necessary to enable us to express the opinions set forth below, including original counterparts or certified copies of the Indenture, the Financing Agreement, the First Mortgage Bond, the other documents listed in the closing memorandum filed with the Trustee and an executed Water Facilities Revenue Bond (Aqua Pennsylvania, Inc. Project) Series C of 2005 as authenticated by the Trustee. Based on the foregoing, it is our opinion that: 1. The Authority is a public instrumentality of the Commonwealth of Pennsylvania and a body corporate and politic, organized and existing under Pennsylvania law, with full power and authority to execute and deliver the Financing Agreement and the Indenture, and to issue and sell the Bonds. 2. The Financing Agreement and the Indenture have been duly authorized, executed and delivered by the Authority and constitute legal, valid and binding obligations of the Authority enforceable against the Authority in accordance with their respective terms, subject to state and federal laws and equitable principles affecting the enforcement of creditors' rights. 3. All right, title and interest of the Authority under the Financing Agreement as they relate to the Bonds, including the right to receive the First Mortgage Bond and the payments thereunder (except for certain rights to indemnification and to payments in respect of administrative expenses of the Authority), have been effectively assigned to the Trustee by the Indenture. 4. The issuance and sale of the Bonds have been duly authorized by the Authority; the Bonds have been duly executed and delivered by the Authority; and, on the assumption that all Bonds have been authenticated by the Trustee, the Bonds are legal, valid and binding obligations of the Authority enforceable against the Authority in accordance with their terms, subject to state and federal laws and equitable principles affecting the enforcement of creditors' rights, and are entitled to the benefit and security of the Indenture. A-2
5. Under existing laws as enacted and construed on the date of initial delivery of the Bonds, interest on the Bonds is excludable from gross income for purposes of federal income tax, assuming the accuracy of the certifications of the Authority and the Company and continuing compliance by the Authority and the Company with the requirements of the Code, except that interest on a Bond is not excludable while the Bond is held by a substantial user of the Project Facilities or a related person as provided in the Code. Interest on the Bonds is a tax preference item that is subject to individual and corporate federal alternative minimum tax. Interest on Bonds held by foreign corporations may be subject to the branch profits tax imposed by the Code. Ownership of the Bonds may result in other federal income tax consequences to certain taxpayers, including, without limitation, financial institutions, property and casualty insurance companies, individual recipients of social security or railroad retirement benefits, certain S corporations and taxpayers who may be deemed to have incurred or continued debt to purchase or carry the Bonds. We express no opinion as to these matters. 6. Under the existing laws of the Commonwealth of Pennsylvania as enacted and construed on the date of initial delivery of the Bonds, interest on the Bonds is exempt from Pennsylvania personal income tax and Pennsylvania corporate net income tax, and the Bonds are exempt from personal property taxes in Pennsylvania. We do not express any opinion herein as to the adequacy or accuracy of the Official Statement of the Authority pertaining to the offering of the Bonds. We call your attention to the fact that the Authority's obligation to make payments in respect of the Bonds is limited to moneys received from payments to be made by the Company pursuant to the First Mortgage Bond and as provided in the Indenture and that the Bonds do not pledge the credit or taxing power of the County of Delaware or the Commonwealth of Pennsylvania or any political subdivision thereof. The Authority has no taxing power. Very truly yours, A-3
EXHIBIT B FORM OF SUPPLEMENTAL OPINION OF BALLARD SPAHR ANDREWS & INGERSOLL, LLP December 28, 2005 Sovereign Securities Corporation, LLC 1500 Market Street Centre Square - Concourse Philadelphia, Pennsylvania 19102 Re: $24,675,000 aggregate principal amount of Delaware County Industrial Development Authority Water Facilities Revenue Bonds, (Aqua Pennsylvania, Inc. Project), Series C of 2005 --------------------------------------------------- Ladies and Gentlemen: Reference is made to our opinion as bond counsel identified as Closing Item No. ____ delivered to you concurrently herewith and relating to the above-referenced Bonds (the "Bonds"). At your request we have undertaken a review of certain other matters pertaining to the Bonds. All terms are used herein with the same meanings ascribed to them in the Official Statement dated December 21, 2005 (the "Official Statement") prepared in connection with the public offering of the Bonds. Based on the review described in our bond opinion, it is our opinion that: 1. The Bond Purchase Agreement dated December 21, 2005 (the "Bond Purchase Agreement"), among you, the Company and the Authority relating to the Bonds has been duly authorized, executed and delivered by the Authority and constitutes the legal, valid and binding obligation of the Authority enforceable against the Authority in accordance with its terms, except as enforceability thereof may be limited by bankruptcy, insolvency or similar laws affecting the enforcement of creditors' rights generally and general principles of equity. 2. The information in the Official Statement under the captions "INTRODUCTORY STATEMENT - Description of the Bonds" and "- Security for the Bonds," "THE BONDS" (other than the information under the sub-caption "Book-Entry Only System") and "SECURITY FOR THE BONDS" (other than the information under the sub-captions "The Mortgage" and "Additional Parity Indebtedness" as to which we express no view) and the information set forth in Appendix C to the Official Statement (other than information under the headings "THE FIRST MORTGAGE BOND AND THE MORTGAGE" as to which we express no view), insofar as such information purports to summarize provisions of the Bonds, the Indenture and the Agreement, fairly and accurately summarize such information in all material respects. The information in the Official Statement under the caption "TAX MATTERS" and the information set forth in Appendix E to the Official Statement accurately reflect our firm's opinion with respect to the matters discussed therein in all material respects. 3. It is not necessary in connection with the offering and sale of the Bonds to register the Bonds under the Securities Act of 1933, as amended, or to qualify the Indenture under the Trust Indenture Act of 1939, as amended. This letter is furnished by us solely for your benefit in connection with the provisions of the Bond Purchase Agreement and may not be relied upon by any other persons for any purpose without our express written permission. Very truly yours, B-1
EXHIBIT C FORM OF OPINION OF COUNSEL FOR THE AUTHORITY December 28, 2005 Delaware County Industrial Development Authority Ballard Spahr Andrews & Ingersoll 200 E. State Street Mellon Bank Center Suite 205 Media, PA 19008 1735 Market Street, 51st Floor Philadelphia, PA 19103 Sovereign Securities Corporation, LLC 1500 Market Street Centre Square - Concourse Philadelphia, PA 19102 Re: $24,675,000 aggregate principal amount of Delaware County Industrial Development Authority Water Facilities Revenue Bonds (Aqua Pennsylvania, Inc. Project) Series C of 2005 --------------------------------------------------- Ladies and Gentlemen: We have acted as counsel to the Delaware County Industrial Development Authority ("Authority") in connection with the authorization, execution and issuance by the Authority of the captioned Bonds ("Bonds"). This opinion is being rendered pursuant to Section 11(c)(iii) of the Bond Purchase Agreement, dated December 21, 2005 (the "Bond Purchase Agreement") by and among Sovereign Securities Corporation, LLC ("Underwriter"), Aqua Pennsylvania, Inc. ("Borrower") and the Authority. Capitalized terms used herein and not otherwise defined shall have the meanings ascribed to them in the Bond Purchase Agreement. As the basis for this opinion, we have examined the Pennsylvania Economic Development Financing Law, 73 P.S. ss.ss. 371 et seq., as amended ("Act"); the Resolution of the Authority relating to the Bonds adopted on November 18, 2005 ("Resolution"), and such other documents, certificates and records of the Authority and other instruments and matters of law as we have deemed necessary to enable us to express the opinion set forth below, including, without limitation, original counterparts or certified copies of the Trust Indenture, dated as of December 15, 2005 ("Indenture"), between the Authority and Wachovia Bank, National Association, as trustee ("Trustee"), the Financing Agreement, dated as of December 15, 2005 ("Financing Agreement"), between the Authority and the Borrower) and the Bond Purchase Agreement. The Indenture, the Loan Agreement and the Bond Purchase Agreement are collectively referred to herein as the "Authority Documents". We have assumed and relied upon the truth, completeness, authority and accuracy of all documents, certificates and instruments examined and the authenticity of all signatures thereon. C-1
We have also assumed that each of the documents referred to herein are, where appropriate, duly authorized and executed by and valid and legally binding obligations of, and enforceable in accordance with their terms against all parties thereto other than the Authority and that the actions required to be taken or consents required to be obtained by such parties have been taken and obtained. In rendering this opinion, we have also assumed that such parties have acted in full compliance with the terms of all applicable laws, regulations and orders. As to questions of fact material to this opinion, we have relied upon certificates and representations of officers and representatives of the Authority or of other public officials, without independent investigation. We have not made any independent investigation in rendering this opinion other than the examination described above. Our opinion is therefore qualified in all respects by the scope of that examination. Our opinions are specifically limited to the present internal laws of the Commonwealth of Pennsylvania ("Commonwealth") and present federal law and no opinion is expressed as to the effect the laws of any other jurisdiction might have upon the subject matter of the opinions expressed herein under conflict of laws principles or otherwise. Based upon the foregoing, and subject to the limitations, assumptions, qualifications and exceptions set forth herein, we are of the opinion that: 1. The Authority is a body corporate and politic constituting an instrumentality of the Commonwealth and is duly created and existing pursuant to the Act. 2. The Authority has duly authorized the execution and issuance of the Bonds and the execution and delivery of the Authority Documents. The Bonds have been duly and validly executed and delivered by the Authority and the Authority Documents have each been duly and validly executed and delivered by the Authority and the Bonds and each of the Authority Documents are valid and binding agreements of the Authority, enforceable against the Authority in accordance with their respective terms. 3. The execution and the issuance by the Authority of the Bonds, the execution and delivery by the Authority of the Authority Documents and performance by the Authority of the Authority's obligations under the Bonds and the Authority Documents, do not conflict with or constitute on a part of the Authority a violation of, breach of or default under any existing constitutional provision or statute of the Commonwealth applicable to the Authority, or, to our knowledge without having undertaken any independent investigation, any indenture, mortgage, deed of trust, resolution, note agreement or other agreement or instrument to which the Authority is a party or by which the Authority is bound and which is known to us, or, to our knowledge, without having undertaken any independent investigation, any order, rule or regulation of any court, governmental agency or body of the Commonwealth having jurisdiction over the Authority or any of its activities or property. 4. To our knowledge, without having undertaken any independent investigation, there is no action, suit, proceeding, inquiry or investigation, at law or in equity, before or by any court, public board or body, pending or threatened against the Authority, wherein an unfavorable decision, ruling or finding would materially and adversely affect the obligations of the Authority under the Bonds. C-2
5. The Authority has approved the distribution of the Preliminary Official Statement dated December 16, 2005 and the Official Statement dated December 21, 2005 ("Official Statement") by the Underwriter in connection with the offering of the Bonds. 6. The information contained in the Official Statement under the heading "INTRODUCTORY STATEMENT - The Authority" and "THE AUTHORITY" has been reviewed by us and nothing has come to our attention which would lead us to believe that such information contains any untrue statement of a material fact or omits to state a material fact which is required to be stated therein or which is necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading in any material respect. The opinions expressed herein are subject in all respects to the following qualifications: (a) no opinion is rendered as to the availability of equitable remedies including, but not limited to, specific performance and injunctive relief, whether enforceability is considered in a processing in equity or at law; (b) no opinion is rendered as to the effect of bankruptcy, reorganization, insolvency, fraudulent conveyance, moratorium and other similar laws or legal principles affecting creditors' rights or remedies; (c) no opinion is rendered as to the creation, perfection or priority of any lien or security interest; (d) no opinion is rendered with respect to any "blue sky" or other securities laws of the Commonwealth or of other jurisdictions; and (e) no opinion is rendered with regard to any federal income tax law or regulation or any state tax law or regulation of the Commonwealth or of other jurisdictions. No opinion is expressed as to the validity or enforceability of any provisions of the Authority Documents: (a) allowing any person or entity to institute judicial or non-judicial proceedings or to exercise any other rights, without notice to the person or entity against whom enforcement is sought; (b) waiving any right or defense of any person or entity; (c) providing or implying the availability of self-help in any particular event or circumstances; (d) relating to court costs or legal fees which may be properly chargeable or recoverable in any judicial proceedings; (e) relating to indemnification; and (f) relating to confession of judgment. We call your attention to the fact that the Bonds are special and limited obligations of the Authority, payable solely from the payments derived by the Authority under the Financing Agreement. The Bonds are not obligations or liabilities of the Commonwealth or the County of Delaware, Pennsylvania or any other political subdivision thereof nor do the Bonds pledge the credit of the Commonwealth or the County of Delaware, Pennsylvania or any other political subdivision thereof nor do the Bonds pledge the credit of the Authority (other than to the limited extent described above). The Authority has no taxing power. This opinion is given as of the date hereof. No opinion is expressed as to any matter not set forth in the numbered paragraphs herein. We make no undertaking to supplement this opinion if facts or circumstances hereafter come to our attention or changes in law occur after the date hereof. This opinion is rendered solely in connection with the original delivery and payment for the Bonds on the date hereof, and may not be relied upon for any other purpose. This opinion may not be relied upon by any other person, including any purchaser of the Bonds from the Underwriter or otherwise or for any other purpose, nor may this opinion be distributed, quoted or disclosed to any person, firm or entity without the prior written consent in each instance of a partner of the undersigned firm. Very truly yours, BLANK ROME LLP C-3
EXHIBIT D FORM OF OPINIONS OF THE COMPANY'S LEGAL COUNSEL AND THE COMPANY'S SENIOR VICE PRESIDENT - LAW AND ADMINISTRATION December 28, 2005 Delaware County Industrial Development Authority 200 East Street, Suite 205 Media, PA 19063 Sovereign Securities Corporation, LLC 1500 Market Street Philadelphia, PA 19102 Re: $24,675,000 aggregate principal amount of Delaware County Industrial Development Authority Water Facilities Revenue Bonds (Aqua Pennsylvania, Inc. Project) Series C of 2005 --------------------------------------------------- Ladies and Gentlemen: We have acted as counsel to Aqua Pennsylvania, Inc. (the "Company") in connection with (i) the issuance by Delaware County Industrial Development Authority (the "Authority"), and the sale to Sovereign Securities Corporation, LLC pursuant to that certain Bond Purchase Agreement dated December 21, 2005 (the "Purchase Agreement"), of $24,675,000 aggregate principal amount of Delaware County Industrial Development Authority Water Facilities Revenue Bonds (Aqua Pennsylvania, Inc.), Series C of 2005 (the "Authority Bonds"), and (ii) the issuance and delivery of $24,675,000 principal amount of the Company's First Mortgage Bond, 5.00% Series due 2035 (the "First Mortgage Bond"), issued under an Indenture of Mortgage (the "Original Mortgage") dated as of January 1, 1941, as amended and supplemented by supplemental indentures thereto, including the Fortieth Supplemental Indenture dated as of December 15, 2005 (the "Fortieth Supplemental Indenture") under which J.P. Morgan Trust Company, National Association is trustee (the "Mortgage Trustee"). The Original Mortgage as amended and supplemented is hereinafter called the "Mortgage". Capitalized terms used herein and not otherwise defined shall have the meanings ascribed to such terms in the Purchase Agreement. We have examined and reviewed, among other things: (a) a copy of the Articles of Incorporation of the Company, as amended and restated and now in effect; (b) a copy of the bylaws of the Company as now in effect; D-1
(c) resolutions of the Board of Directors of the Company authorizing the execution and delivery of the Purchase Agreement, the Financing Agreement, the Fortieth Supplemental Indenture, the First Mortgage Bond, the Continuing Disclosure Agreement and the Official Statement; (d) the Purchase Agreement; (e) the Financing Agreement dated as of December 15, 2005 (the "Financing Agreement") between the Authority and the Company; (f) the Continuing Disclosure Agreement dated as of December 15, 2005 (the "Continuing Disclosure Agreement") between the Company and Wachovia Bank, National Association, as trustee for the Authority Bonds (the "Trustee"); (g) the Official Statement relating to the Authority Bonds dated December 21, 2005 (the "Official Statement"); (h) the Securities Certificate relating to the issue and sale of the First Mortgage Bond, filed by the Company with the Pennsylvania Public Utility Commission pursuant to the provisions of Chapter 19 of the Pennsylvania Public Utility Code, and a copy of the Order of the Public Utility Commission registering such Securities Certificate, certified by the Secretary of the Pennsylvania Public Utility Commission; (i) a Subsistence Certificate from the Secretary of the Commonwealth with respect to the Company; (j) executed counterparts of the Original Mortgage and of the Fortieth Supplemental Indenture supplemental thereto and evidence satisfactory to us of the due recordation thereof in the Counties of Adams, Berks, Bradford, Bucks, Carbon, Chester, Columbia, Cumberland, Delaware, Forest, Juniata, Lackawanna, Lawrence, Luzerne, Mercer, Monroe, Montgomery, Northampton, Northumberland, Pike, Schuylkill, Snyder, Susquehanna, Wayne and Wyoming, Pennsylvania; (k) the documents delivered to the Mortgage Trustee in connection with the authentication of the First Mortgage Bond pursuant to the provisions of Sections 2(B) and 3 of Article IV of the Original Mortgage; (l) the First Mortgage Bond delivered to the Trustee at the Closing held today; (m) the certificates of the Company and other documents delivered to the Mortgage Trustee at the Closing; (n) a certificate of the Company and various bringdown title searches of various title companies in the Counties of Adams, Berks, Bradford, Bucks, Carbon, Chester, Columbia, Cumberland, Delaware, Forest, Juniata, Lackawanna, Lawrence, Luzerne, Mercer, Monroe, Montgomery, Northampton, Northumberland, Pike, Schuylkill, Snyder, Susquehanna, Wayne and Wyoming, Pennsylvania, each dated as of a recent date (collectively, "Title Searches"), as to matters relating to title to real estate and the lien of the Mortgage thereon, on which certificate and searches we are relying for the purposes of this opinion; and (o) various certificates of officers of the Company relating to title to real property and the priority of any lien thereon. D-2
In rendering this opinion, we have assumed that all signatures on documents and instruments examined by us are genuine (except signatures of the Company on the Purchase Agreement, the Fortieth Supplemental Indenture, the Financing Agreement, the First Mortgage Bond and the Continuing Disclosure Agreement (collectively, the "Company Documents") and the Official Statement), the authenticity of all documents submitted to us as originals and the conformity with the original documents of all documents submitted to us as copies. We have also assumed, with your permission, that none of the signatories of the documents and instruments referred to above is an affiliate of the Company within the meaning of 66 Pa.C.S. ss.2101 (1989). As to questions of fact material to the opinions hereinafter expressed, we have relied solely and without investigation upon certificates of public officials, certificates of officers of the Company and the representations of the Company contained in the Company Documents (including the exhibits and schedules to such documents) and the certificates and other documents delivered pursuant thereto. To the extent that the opinions contained herein are given to the best of our knowledge, such knowledge means the actual knowledge of those attorneys within our firm who have provided substantive representation to the Company in connection with this financing, without investigation and inquiry, and does not include matters of which such attorneys could be deemed to have constructive knowledge. In rendering this opinion, we have also assumed that each of the Company Documents has been duly authorized, executed and delivered by each party thereto (other than the Company) and that each of the Company Documents is binding and enforceable against each such party in accordance with its respective terms. Further, as to matters relating to title to real estate and the lien of the Mortgage, we have relied exclusively upon various certificates of officers of the Company and the Title Searches and we have not made, nor undertaken to make, any investigation or inquiry with respect to title to real property or the priority of any lien thereon. We are generally familiar with the Company's operations as a public utility within the Commonwealth of Pennsylvania (the "Commonwealth"). Based upon the foregoing and such other examination of fact and law as we have deemed necessary for purposes of this opinion, we are of the opinion that: 1. The Company was organized and subsists under the laws of the Commonwealth, with power (corporate and other) to own its properties and conduct its business as described in the Official Statement. 2. The Company has the corporate power and authority to enter into and perform the Purchase Agreement, the Financing Agreement, the First Mortgage Bond, the Fortieth Supplemental Indenture and the Continuing Disclosure Agreement. The execution, delivery and performance by the Company of the Financing Agreement, the Bond Purchase Agreement, the First Mortgage Bond, the Fortieth Supplemental Indenture and the Continuing Disclosure Agreement have been duly authorized by all requisite corporate action. D-3
3. The Purchase Agreement, the Financing Agreement and the Continuing Disclosure Agreement constitute legal, valid and binding obligations of the Company, enforceable against the Company in accordance with their respective terms. 4. The First Mortgage Bond has been duly authorized, executed, authenticated, issued and delivered and each constitutes a valid and legally binding obligation of the Company entitled to the benefits provided by the Mortgage. 5. The First Mortgage Bond is not subject to the registration requirements of the 1933 Act. 6. The Mortgage constitutes a direct, valid and enforceable mortgage lien (except as enforceability of such lien may be limited by bankruptcy, insolvency, reorganization or other laws affecting the enforcement of creditors' rights) upon all of the properties and assets of the Company (not heretofore released as provided for in the Mortgage) specifically or generally described or referred to in the Mortgage as being subject to the lien thereof, except for permitted liens under the Mortgage; the Original Mortgage, either separately or as an exhibit to the Thirty-Fifth Supplemental Indenture dated as of January 1, 2002 or the Thirty-Eighth Supplemental Indenture dated as of November 15, 2004, and the Fortieth Supplemental Indenture dated as of December 15, 2005 has been properly recorded in the Counties of Adams, Berks, Bradford, Bucks, Carbon, Chester, Columbia, Cumberland, Delaware, Forest, Juniata, Lackawanna, Lawrence, Luzerne, Mercer, Monroe, Montgomery, Northampton, Northumberland, Pike, Schuylkill, Snyder, Susquehanna, Wayne and Wyoming in the Commonwealth and such recordations are the only recordations necessary in order to establish, preserve, protect and perfect the lien of the Mortgage on all real estate and fixed property of the Company (excluding easement and other similar rights) described in the Mortgage as subject to the lien thereof. 7. In each of the following cases with such exceptions as are not material and do not interfere with the conduct of the business of the Company, the Company has good and marketable title to all of its real property currently held in fee simple; good and marketable title to all of its other interests in real property (other than to certain rights of way, easements, occupancy rights, riparian and flowage rights, licenses, leaseholds, and real property interests of a similar nature); and good and marketable title to all personal property owned by it; in each case free and clear of all liens, encumbrances and defects except such as may be described in the Official Statement, the lien of the Mortgage, permitted liens under the Mortgage or such as do not materially affect the value of such property and do not interfere with the use made and proposed to be made of such property by the Company; and any real property and buildings held under lease by the Company are held by it under valid, subsisting and enforceable leases with such exceptions as are not material and do not interfere with the use made and proposed to be made of such property and buildings by the Company. D-4
8. The Company is not a holding company, a registered holding company or an affiliate of a registered holding company within the meaning of the Public Utility Company Holding Act of 1935, as amended. 9. The Mortgage and the First Mortgage Bond conform in all material respects as to legal matters to the descriptions thereof in the Official Statement. Without having undertaken to determine independently the accuracy, completeness and fairness of the statements contained in the Official Statement, nothing has come to our attention in connection with our representation of the Company in respect of the issuance of the First Mortgage Bond which leads us to believe that the information with respect to the Company contained in the Official Statement (including Appendix A and the information incorporated therein by reference) contains any untrue statement of a material fact or omits to state a material fact which is required to be stated therein or which is necessary to make such information and descriptions, in the light of the circumstances under which they were made, not misleading in any material respect. The foregoing opinions are subject to the following qualifications: (i) The opinions expressed in paragraphs 3 and 4 are subject to the qualifications that the enforceability of the First Mortgage Bond are subject to (i) applicable bankruptcy, insolvency, reorganization, moratorium, and other similar laws of general application relating to or affecting creditors' rights, (ii) certain provisions of Pennsylvania law affecting the availability of certain remedies, and (iii) the further qualification that the availability of specific performance, injunctive relief or other equitable remedies is subject to the discretion of the court before which any proceeding therefor may be brought. (ii) Our opinions are subject to limitations imposed by general principles of equity, including principles of commercial reasonableness, good faith and fair dealing (regardless of whether enforcement is considered in proceedings at law or in equity). (iii) We express no opinion as to the enforceability with respect to any provisions purporting to waive the effect of applicable laws and remedies and any provisions releasing any party from, or requiring indemnification for, liability for gross negligence, recklessness or willful misconduct. (iv) Any requirements in any of the documents specifying that provisions of a document may only be waived in writing may not be enforced to the extent that an oral agreement or an implied agreement by trade practice or course of conduct has been created modifying any provision of such document. (v) We express no opinion as to the applicability to the transactions contemplated by the Company Documents of Section 548 of the Bankruptcy Code or any applicable state law relating to fraudulent transfers and obligations. (vi) Other applicable local, state and federal laws, regulations and ordinances, court decisions and constitutional requirements may limit or render unenforceable certain of the rights or remedies contained in the Company Documents, but in our opinion, none of the same would materially impair the practical realization of the benefits intended to be provided by the Company pursuant to the Company Documents. D-5
(vii) Our opinion is limited in all respects to the laws of the Commonwealth in effect as of the date hereof and we express no opinion as to the laws of any other jurisdiction. (viii) This opinion is limited to the matters set forth herein, no opinion may be inferred or implied beyond the matters expressly stated herein, and our statements contained in the opinion portion of this letter must be read in conjunction with the assumptions, limitations, exceptions and qualifications set forth in this letter. (ix) The opinions herein are expressed as of the date hereof only and not as of some future date. We undertake no responsibility to advise you of any change in law or new laws, regulations or judicial decisions in the future. Nor do we assume any obligation to update or supplement this opinion to reflect any facts or circumstances which may hereafter come to our attention. References to "laws," "regulations" and "judicial decisions" herein shall include only officially published laws and regulations of the Commonwealth of Pennsylvania. This opinion is solely for the benefit of each of you and the benefit of any subsequent holder of the First Mortgage Bond or the Authority Bonds and may not be relied upon by any other person or for any other purpose. Very truly yours, D-6
[Letterhead of Aqua Pennsylvania] December 28, 2005 Sovereign Securities Corporation, LLC 1500 Market Street Philadelphia, PA 19102 Re: $24,675,000 aggregate principal amount of Delaware County Industrial Development Authority Water Facilities Revenue Bonds (Aqua Pennsylvania, Inc. Project) Series C of 2005 ---------------------------------------------------------- Ladies and Gentlemen: I am Senior Vice President-Law and Administration for Aqua Pennsylvania, Inc. (the "Company"). Pursuant to Section 11(c)(iv) of the Bond Purchase Agreement dated December 21, 2005 (the "Purchase Agreement") among the Authority, the Underwriter and the Company (f/k/a Pennsylvania Suburban Water Company, as successor by merger to Philadelphia Suburban Water Company) relating to the Authority Bonds, I have been asked to render an opinion to you regarding certain matters involving the Company. Capitalized terms used herein and not otherwise defined shall have the definitions ascribed to such terms in the Purchase Agreement. In rendering this opinion, I have assumed the following: i. the genuineness of all signatures (other than the signatures of the Company on the Fortieth Supplemental Mortgage, as hereinafter defined); ii. the authenticity and completeness of all documents submitted to me as originals; iii. the conformity to original documents of all documents submitted to me as copies, and the authenticity of the originals of such copies; iv. the entity executing the Mortgage as trustee is duly organized and validly existing, in good standing under the laws of the jurisdiction of its organization, is properly qualified to do business in all jurisdictions in which the business conducted by it makes such qualification necessary and has all necessary legal and corporate power and authority to enter into and perform its obligations under the Mortgage; v. the due authorization, execution and delivery of the Mortgage by or on behalf of the party thereto other than the Company; D-7
vi. the enforceability against each party thereto (other than the Company) of the Mortgage in accordance with its respective terms; and vii. that the execution, delivery and performance of the Mortgage by the entity other than the Company which is party thereto does not and will not conflict with, result in any breach of, or constitute a default under any order, writ, injunction or decree of any court or governmental authority, or any agreement, indenture or other instrument, to which any such party is a party or by which it or its properties are bound, and that all necessary approvals, consents, permits, registrations, filings or other notices to or grants of authority from any federal or local governmental body necessary for the execution, delivery and performance of the Mortgage by each party thereto (other than the Company) have been duly received or made, with all appeal periods expired and no appeals taken. I am making each of the foregoing assumptions with your permission and with the disclaimer that we make no representation as to the accuracy of such assumptions, although I have no knowledge that any such assumption is untrue. In my opinion: 1. In each of the following cases with such exceptions as are not material and do not materially interfere with the conduct of the business of the Company: (a) the Company has all licenses, franchises, permits, authorizations, rights, approvals, consents and order of all governmental authorities or agencies necessary for the ownership or lease of the properties owned or leased by it and for the operation of the business carried on by it as described in the Official Statement, and all water rights, riparian rights, easements, rights of way and other similar interests and rights described or referred to in the Mortgage necessary for the operation of the business carried on by it as described in the Official Statement; (b) except as otherwise set forth in the Official Statement, all such licenses, franchises, permits, orders, authorizations, rights, approvals and consents are in full force and effect and contain no unduly burdensome provisions; (c) to the best of my knowledge, except as otherwise set forth in the Official Statement, there are no legal or governmental proceedings pending or, to my knowledge, threatened that would result in a material modification, suspension or revocation thereof; and (d) the Company has the legal power to exercise the rights of eminent domain for the purposes of conducting its water utility operations. 2. The issue and sale of the Bonds; the issue and delivery of the First Mortgage Bond and the compliance by the Company with all of the applicable provisions of the First Mortgage Bond and the Mortgage; and the execution, delivery and performance by the Company of the Fortieth Supplemental Mortgage, the Financing Agreement, the Purchase Agreement and the Continuing Disclosure Agreement will not materially conflict with or result in a material breach of any of the terms or provisions of, or constitute a material default under, or result in the creation or imposition of any material lien, charge or encumbrance (other than the lien of the Mortgage) upon any of the property or assets of the Company pursuant to the terms of, any indenture, mortgage, deed of trust, loan agreement or other agreement or instrument to which the Company is a party or by which the Company is bound or to which any of the property or assets of the Company is subject, nor will such action result in a violation of the provisions of the Articles of Incorporation, as amended, or the Bylaws of the Company or any statute or any order, rule or regulation of any court or governmental agency or body having jurisdiction over the Company or any of its property. No consent, approval, authorization, order, registration or qualification of or with any court or any such regulatory authority or other governmental body not already obtained is required for the issue and delivery of the First Mortgage Bond, the execution, delivery and performance of the Purchase Agreement, the Financing Agreement, the Fortieth Supplemental Mortgage, the First Mortgage Bond, and the Continuing Disclosure Agreement, or the consummation of the other transactions contemplated by the Purchase Agreement or the Mortgage. D-8
3. There are no legal or governmental proceedings pending to which the Company is a party or of which any property of the Company is the subject, other than as set forth in the Official Statement and other than litigation incident to the kind of business conducted by the Company, wherein an unfavorable ruling, decision or finding is likely that would have a material adverse effect on the financial position, stockholders' equity or results of operations of the Company. 4. Each of the Indenture of Mortgage dated as of January 1, 1941 (the "Original Mortgage"), between the Company and The Philadelphia Company for Insurance on Lives and Exacting Annuities (now J.P. Morgan Trust Company, National Association, as successor in interest), as trustee (the "Trustee") and the forty indentures supplemental thereto, including the Fortieth Supplemental Indenture dated as of December 15, 2005 between the Company and the Trustee (the Original Mortgage as so supplemented and amended, the "Mortgage") was duly authorized, executed and delivered by the Company and the Mortgage constitutes a legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms (subject to applicable bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium or other similar laws relating to creditors' rights generally from time to time in effect, and subject, as to enforceability, to general principles of equity, regardless of whether such enforceability is considered in a proceeding in equity or at law). The foregoing opinions are subject to the following qualifications: i. The enforceability of the Mortgage, including, without limitation, any non-judicial and self-help remedies and waivers contained therein, may be limited by bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance or other similar laws affecting the rights of creditors generally and are subject to limitations imposed by general principles of equity, including principles of commercial reasonableness, good faith and fair dealing (regardless of whether enforcement is considered in proceedings at law or in equity), public policy and applicable law which may limit the availability of the remedies provided for therein, ii. I express no opinion as to the adequacy of any notice with respect to the disposition of any collateral. I also express no opinion as to the effectiveness or enforceability of provisions relating to waivers of notice or waivers of other rights, severability, prepayment fees or penalties, choice of law, or any provisions which release or limit the Company's liability or relate to cumulative remedies or, to the extent they purport to or would have the effect of compensating the Company in amounts in excess of any actual loss suffered by the Company, provisions relating to the payment of a default rate of interest. D-9
iii. I express no opinion as to enforceability with respect to any provisions in the Mortgage executed by the Company purporting to waive the effect of applicable laws and remedies and any provisions releasing any party from, or requiring indemnification for, liability for gross negligence, recklessness or willful misconduct. iv. Requirements in the Mortgage specifying that provisions of the Mortgage may only be waived in writing may not be enforced to the extent that an oral agreement or an implied agreement by trade practice or course of conduct has been created modifying any provision of such Mortgage. v. My opinion is limited in all respects to laws of the Commonwealth of Pennsylvania in effect as of the date hereof and we express no opinion as to the laws of any other jurisdiction. vi. This opinion is limited to the matters set forth herein, no opinion may be inferred or implied beyond the matters expressly stated herein, and our statements contained in the opinion portion of this letter must be read in conjunction with the assumptions, limitations, exceptions and qualifications set forth in this letter. vii. The opinions herein are expressed as of the date hereof only and not as of some future date. I undertake no responsibility to advise you of any change in law or new laws, regulations or judicial decisions in the future nor do I assume any obligation to update or supplement this opinion to reflect any facts or circumstances which may hereafter come to our attention. References to "laws," "regulations" and "judicial decisions" herein shall include only officially published laws and regulations of the Commonwealth of Pennsylvania. This opinion is solely for your benefit and may not be relied upon by any other person or for any other purpose. Very truly yours, Roy H. Stahl D-10
EXHIBIT 10.39 AQUA AMERICA, INC. AMENDED AND RESTATED 2001 EMPLOYEE STOCK PURCHASE PLAN (as amended and restated on January 1, 2006) The purpose of the Aqua America, Inc. Amended and Restated 2001 Employee Stock Purchase Plan is to provide eligible employees of Aqua America, Inc. (the "Company") and its subsidiaries an opportunity to purchase the common stock of the Company. The Board of Directors of the Company believes that employee participation in stock ownership will be to the mutual benefit of the employees and the Company. The Plan must be approved by the stockholders of the Company within 12 months after the date on which the Plan is adopted. ARTICLE I DEFINITIONS SECTION 1.01 "Board of Directors" means the Board of Directors of the Company. SECTION 1.02 "Code" means the Internal Revenue Code of 1986, as amended. References to specific sections of the Code shall be taken to be references to corresponding sections of any successor statute. SECTION 1.03 "Committee" means the committee appointed by the Board of Directors to administer the Plan, as provided in Section 5.04. SECTION 1.04 "Company" means Aqua America, Inc., a Pennsylvania corporation, or any successor by merger or otherwise. SECTION 1.05 "Compensation" means a Participant's base wages, overtime pay, commissions, cash bonuses, premium pay and shift differential, before giving effect to any compensation reductions made in connection with plans described in section 401(k) or 125 of the Code. SECTION 1.06 "Effective Date" shall mean March 6, 2001. SECTION 1.07 "Election Date" means the first business day of each calendar month during which the Plan is in effect, or such other dates as the Committee shall specify; provided that the first Election Date for the Plan shall be the Effective Date. SECTION 1.08 "Eligible Employee" means each employee of the Employer: (i) Who is employed by the Employer and (a) who is classified by the Employer as an "active regular or part-time non-union employee" or as an "active full or part-time union employee" and (b) each person who is not so classified, if such person's customary employment is for more than twenty (20) hours per week and for more than five months per year, and
(ii) Who is not deemed for purposes of section 423(b)(3) of the Code to own stock possessing five percent or more of the total combined voting power or value of all classes of stock of the Company or any subsidiary. SECTION 1.09 "Employer" means the Company and each Subsidiary. SECTION 1.10 "Exchange Act" means the Securities Exchange Act of 1934, as amended, and as the same may hereafter be amended. SECTION 1.11 "Market Value" means the average of the high and low trading prices for the Stock as reported on the principal market on which the Stock is traded for the date of reference. If there was no such price reported for the date of reference, "Market Value" means the average of the high and low trading prices for the Stock on the day next preceding the date of reference for which such price was reported or, if there was no such reported price, the fair market value as determined by the Committee. SECTION 1.12 "Participant" means each Eligible Employee who elects to participate in the Plan. SECTION 1.13 "Plan" means the Aqua America, Inc. Amended and Restated 2001 Employee Stock Purchase Plan, as set forth herein and as hereafter amended. SECTION 1.14 "Plan Year" means each calendar year during which the Plan is in effect. SECTION 1.15 "Purchase Agreement" means the instrument prescribed by the Committee pursuant to which an Eligible Employee may enroll as a Participant and subscribe for the purchase of shares of Stock on the terms and conditions offered by the Company. The Purchase Agreement is intended to evidence the Company's offer of an option to the Eligible Employee to purchase Stock on the terms and conditions set forth therein and herein. SECTION 1.16 "Purchase Date" means the last day of each Purchase Period. SECTION 1.17 "Purchase Period" means each one month period or other period specified by the Committee, beginning on or after the Effective Date, during which the Participant's Stock purchase is funded through payroll deduction accumulations or a lump sum deposit under Section 3.05(b). SECTION 1.18 "Purchase Price" means the purchase price for shares of Stock purchased under the Plan, determined as set forth in Section 3.03. SECTION 1.19 "Stock" means the common stock of the Company. SECTION 1.20 "Subsidiary" means any present or future corporation which (i) constitutes a "subsidiary corporation" of the Company as that term is defined in section 424 of the Code and (ii) is designated as a participating entity in the Plan by the Committee. Unless the Committee specifically designates otherwise, a Canadian or other foreign subsidiary shall not be considered a Subsidiary for purposes of the Plan, and employees of such a subsidiary shall not be Eligible Employees.
ARTICLE II ADMISSION TO PARTICIPATION SECTION 2.01 Initial Participation. An Eligible Employee may elect to participate in the Plan and may become a Participant effective as of any Election Date, by executing and filing with the Committee a Purchase Agreement at such time in advance of the Election Date as the Committee shall prescribe. The Purchase Agreement shall remain in effect until it is modified through discontinuance of participation under Section 2.02 or a change under Section 3.05. SECTION 2.02 Discontinuance of Participation. (a) A Participant may voluntarily cease his or her participation in the Plan and stop payroll deductions at any time by filing a notice of cessation of participation on such form and at such time in advance of the Purchase Date as the Committee shall prescribe. A Participant who ceases contributions during a Purchase Period may make additional contributions to the Plan during the Purchase Period. The Participant may again elect to make payroll deductions on the next Election Date, if the Participant is then an Eligible Employee. A Participant who ceases contributions during a Purchase Period may request payment of any funds held in his or her account under the Plan. Any funds remaining in the Participant's account on the Purchase Date shall be used to purchase Stock pursuant to Section 3.04, if the Participant remains an Eligible Employee. (b) If a Participant ceases to be an Eligible Employee, his or her participation automatically shall cease, no further purchase of Stock shall be made for the Participant, and the Participant shall receive payment of any funds held in his or her account under the Plan. SECTION 2.03 Readmission to Participation. Any Eligible Employee who has previously been a Participant, who has discontinued participation (whether by cessation of eligibility or otherwise), and who wishes to be reinstated as a Participant may again become a Participant by executing and filing with the Committee a new Purchase Agreement. Reinstatement to Participant status shall be effective as of any Election Date, provided the Participant files a new Purchase Agreement with the Committee at such time in advance of the Election Date as the Committee shall prescribe. SECTION 2.04 Leave of Absence. A Participant who is on an approved leave of absence may continue to participate in the Plan during the leave of absence by making cash payments to the Company, at such times as the Committee determines, equal to the payroll deductions that would have been made had the leave of absence not occurred. ARTICLE III STOCK PURCHASE AND RESALE SECTION 3.01 Reservation of Shares. There shall be 300,000 shares of Stock reserved for issuance or transfer under the Plan, subject to adjustment in accordance with Section 4.02. Except as provided in Section 4.02, the aggregate number of shares of Stock that may be purchased under the Plan shall not exceed the number of shares of Stock reserved under the Plan. The shares of Stock may be (i) Treasury or newly issued shares of the Company or (ii) purchased by the Company on the open market.
SECTION 3.02 Limitation on Shares Available. (a) The maximum number of shares of Stock that may be purchased for each Participant on a Purchase Date is the lesser of (a) the number of whole and fractional shares of Stock that can be purchased by applying the full balance of the Participant's withheld funds to the purchase of shares of Stock at the Purchase Price, or the Participant's proportionate part of the maximum number of shares of Stock available under the Plan, as stated in Section 3.01. (b) Notwithstanding the foregoing, if any person entitled to purchase shares pursuant to any offering under the Plan would be deemed for purposes of section 423(b)(3) of the Code to own stock (including any number of shares of Stock that such person would be entitled to purchase under the Plan) possessing five percent or more of the total combined voting power or value of all classes of stock of Company, the maximum number of shares of Stock that such person shall be entitled to purchase pursuant to the Plan shall be reduced to that number which, when added to the number of shares of stock that such person is deemed to own (excluding any number of shares of Stock that such person would be entitled to purchase under the Plan), is one less than such five percent. Any amounts withheld from a Participant's compensation that cannot be applied to the purchase of Stock by reason of the foregoing limitation shall be returned to the Participant as soon as practicable. (c) A Participant may not purchase shares of Stock having an aggregate Market Value of more than $25,000, determined at the beginning of each Purchase Period, for any calendar year in which one or more offerings under this Plan are outstanding at any time, and a Participant may not purchase a share of Stock under any offering after the expiration of the Purchase Period for the offering. SECTION 3.03 Purchase Price of Shares. (a) Unless the Committee determines otherwise, the Purchase Price per share of the Stock to be sold to Participants under the Plan shall be the lower of: (i) 85% of the Market Value of such share on the first day of the Purchase Period, or (ii) 85% of the Market Value of such share on the Purchase Date. (b) The Committee may determine that the Purchase Price shall be the Market Value, or a percentage of the Market Value, on either of the first day of the Purchase Period or the Purchase Date, or the lower of such values, so long as the percentage shall not be lower than 85% of such Market Value.
SECTION 3.04 Exercise of Purchase Privilege. (a) As of the first day of each Purchase Period, each Participant shall be granted an option to purchase shares of Stock at the Purchase Price specified in Section 3.03. The option shall continue in effect through the Purchase Date for the Purchase Period. Subject to the provisions of Section 3.02 above, on each Purchase Date, the Participant shall automatically be deemed to have exercised his or her option to purchase shares of Stock, unless he or she notifies the Committee, in such manner and at such time in advance of the Purchase Date as the Committee shall prescribe, of his or her desire not to make such purchase. (b) Subject to the provisions of Section 3.02, there shall be purchased for the Participant on each Purchase Date, at the Purchase Price for the Purchase Period, the largest number of whole shares of Stock and fractional shares as can be purchased with the amounts withheld from the Participant's Compensation or deposited by the Participant as described in Section 3.05(b) during the Purchase Period. Each such purchase shall be deemed to have occurred on the Purchase Date occurring at the close of the Purchase Period for which the purchase was made. Any amounts that are withheld from a Participant's Compensation in a Purchase Period and that remain after the purchase of whole shares of Stock on a Purchase Date will be held in the Participant's account, without interest, and applied on the Participant's behalf to purchase Stock on the next Purchase Date. SECTION 3.05 Payroll Deductions and Deposits. (a) Each Participant shall authorize payroll deductions from his or her Compensation for the purpose of funding the purchase of Stock pursuant to his or her Purchase Agreement. In the Purchase Agreement, each Participant shall authorize an after-tax payroll deduction from each payment of Compensation during the Purchase Period of an amount (i) not less than $5.00 per paycheck for a Participant who is paid on a weekly payroll period basis or $10.00 per paycheck for a Participant who is paid biweekly or semi-monthly payroll period basis, and (ii) not more than ten percent (10%) of such Participant's Compensation, rounded to the next highest whole dollar amount. A Participant may change the deduction to any permissible level effective as of any Election Date. A change shall be made by filing with the Committee a notice in such form and at such time in advance of the Election Date on which the change is to be effective as the Committee shall prescribe. (b) The Committee may allow Participants to deposit funds with the Company to be used for the purpose of purchasing Stock pursuant to their Purchase Agreements, instead of or in addition to payroll deductions pursuant to Section 3.05(a) subject to the following: (i) only one deposit as described in this paragraph shall be accepted in Purchase Period, (ii) the minimum amount that a Participant may contribute to the Plan pursuant to this paragraph shall be twenty-five dollars ($25) per Purchase Period and (iii) the total amount that the Participant may contribute to the Plan pursuant to this paragraph together with all payroll deductions pursuant to paragraph (a) above may not exceed the $25,000 limitation specified in paragraph (d) of Section 3.02 above. The Committee shall designate the dates by which any such deposits must be made for a Purchase Period.
(c) Dividends will be paid on all whole and fractional shares purchased by a Participant. Unless otherwise directed by the Participant, all dividends paid with respect to shares purchased by each Participant will be automatically be reinvested under the Aqua America, Inc. Dividend Reinvestment and Direct Stock Purchase Plan. SECTION 3.06 Payment for Stock. The Purchase Price for all shares of Stock purchased by a Participant under the Plan shall be paid out of the Participant's authorized payroll deductions and any deposits made by a Participant pursuant to Section 3.05(b). All funds received or held by the Company under the Plan are general assets of the Company, shall be held free of any trust or other restriction, and may be used for any corporate purpose. SECTION 3.07 Share Ownership; Issuance of Certificates. (a) The shares of Stock purchased by a Participant on a Purchase Date shall, for all purposes, be deemed to have been issued or sold at the close of business on the Purchase Date. Prior to that time, none of the rights or privileges of a stockholder of the Company shall inure to the Participant with respect to such shares of Stock. All the shares of Stock purchased under the Plan shall be delivered by the Company in a manner as determined by the Committee. (b) The Committee, in its sole discretion, may determine that shares of Stock shall be delivered by (i) issuing and delivering to the Participant a certificate for the number of shares of Stock purchased by the Participant, (ii) issuing and delivering certificates for the number of shares of Stock purchased to a firm which is a member of the National Association of Securities Dealers, as selected by the Committee from time to time, which shares shall be maintained by such firm in a separate brokerage account for each Participant, or (iii) issuing and delivering certificates for the number of shares of Stock purchased by Participants to a bank or trust company or affiliate thereof, as selected by the Committee from time to time, which shares may be held by such bank or trust company or affiliate in street name, but with a separate account maintained by such entity for each Participant reflecting such Participant's share interests in the Stock. Each certificate or account, as the case may be, may be in the name of the Participant or, if he or she so designates on the Participant's Purchase Agreement, in the Participant's name jointly with the Participant's spouse, with right of survivorship, or in such other form as the Committee may permit. (c) The Committee, in its sole discretion, may impose such restrictions or limitations as it shall determine on the resale of Stock, the issuance of individual stock certificates or the withdrawal from any stockholder accounts established for a Participant. SECTION 3.08 Distribution of Shares or Resale of Stock. (i) In accordance with the procedures established by the Committee, a Participant may request a distribution of shares of Stock purchased for the Participant under the Plan or order the sale of such shares at any time by making a request in such form and at such time as the Committee shall prescribe. (ii) If a Participant terminates his or her employment with the Employer or otherwise ceases to be an Eligible Employee, the Participant shall receive a distribution of his or her shares of Stock held in any stockholder account established pursuant to Section 3.07(b), unless the Participant elects to have the shares of Stock sold in accordance with such procedures as the Committee shall prescribe.
(b) If a Participant is to receive a distribution of shares of Stock, or if shares are to be sold, the distribution or sale shall be made in whole shares of Stock, with fractional shares paid in cash. Any brokerage commissions resulting from a sale of Stock shall be deducted from amounts payable to the Participant. ARTICLE IV SPECIAL ADJUSTMENTS SECTION 4.01 Shares Unavailable. If, on any Purchase Date, the aggregate funds available for the purchase of Stock would purchase a number of shares in excess of the number of shares of Stock then available for purchase under the Plan, the following events shall occur: (a) The number of shares of Stock that would otherwise be purchased by each Participant shall be proportionately reduced on the Purchase Date in order to eliminate such excess; (b) The Plan shall automatically terminate immediately after the Purchase Date as of which the supply of available shares is exhausted; and (c) Any amounts remaining shall be repaid the Participants. SECTION 4.02 Anti-Dilution Provisions. The aggregate number of shares of Stock reserved for purchase under the Plan, as provided in Section 3.01, the maximum number of shares that may be purchased by a Participant as provided in Section 3.02(b), and the calculation of the Purchase Price per share may be appropriately adjusted by the Committee to reflect any increase or decrease in the number of issued shares of Stock resulting from a subdivision or consolidation of shares or other capital adjustment, or the payment of a stock dividend, or other increase or decrease in such shares, if effected without receipt of consideration by the Company. SECTION 4.03 Effect of Certain Transactions. Subject to any required action by the stockholders, if the Company shall be the surviving corporation in any merger or consolidation, any offering hereunder shall pertain to and apply to the shares of Stock of the Company. However, in the event of a dissolution or liquidation of the Company, or of a merger or consolidation in which the Company is not the surviving corporation, the Plan and any offering hereunder shall terminate upon the effective date of such dissolution, liquidation, merger or consolidation, unless the Board determines otherwise, and the balance of any amounts withheld from a Participant's Compensation or deposited pursuant to Section 3.05(b) which have not by such time been applied to the purchase of Stock shall be returned to the Participant. ARTICLE V MISCELLANEOUS SECTION 5.01 Non-Alienation. Except as set forth below, the right to purchase shares of Stock under the Plan is personal to the Participant, is exercisable only by the Participant during the Participant's lifetime and may not be assigned or otherwise transferred by the Participant. If a Participant dies, unless the executor, administrator or other personal representative of the deceased Participant directs otherwise, any amounts previously withheld from the Participant's Compensation or deposited pursuant to Section 3.05(b) before the Participant's death during the Purchase Period in which the Participant dies shall be used to purchase Stock on the Purchase Date for the Purchase Period. After that Purchase Date, there shall be delivered to the executor, administrator or other personal representative of the deceased Participant all shares of Stock and such residual amounts as may remain to the Participant's credit under the Plan.
SECTION 5.02 Administrative Costs. The Company shall pay the administrative expenses associated with the operation of the Plan (other than brokerage commissions resulting from sales of Stock directed by Participants). SECTION 5.03 No Interest. No interest shall be payable with respect to amounts withheld or deposited under the Plan. SECTION 5.04 Committee. The Board of Directors shall appoint the Committee, which shall have the authority and power to administer the Plan and to make, adopt, construe, and enforce rules and regulations not inconsistent with the provisions of the Plan. The Committee shall adopt and prescribe the contents of all forms required in connection with the administration of the Plan, including, but not limited to, the Purchase Agreement, payroll withholding authorizations, requests for distribution of shares, and all other notices required hereunder. The Committee shall have the fullest discretion permissible under law in the discharge of its duties. The Committee's interpretations and decisions with respect to the Plan shall be final and conclusive. SECTION 5.05 Withholding of Taxes; Notification of Transfer. (a) All acquisitions and sales of Stock under the Plan shall be subject to applicable federal (including FICA), state and local tax withholding requirements if the Internal Revenue Service or other taxing authority requires such withholding. The Company may require that Participants pay to the Company (or make other arrangements satisfactory to the Company for the payment of) the amount of any federal, state or local taxes that the Company is required to withhold with respect to the purchase of Stock or the sale of Stock acquired under the Plan, or the Company may deduct from the Participant's wages or other compensation the amount of any withholding taxes due with respect to the purchase of Stock or the sale of Stock acquired under the Plan. (b) A Participant shall be required to advise the Committee immediately if the Participant transfers (by sale, gift or other manner) any shares of Stock acquired under the Plan within two years after the beginning of the Purchase Period in which the Stock is purchased. SECTION 5.06 Amendment of the Plan. The Board of Directors may, at any time and from time to time, amend the Plan in any respect, except that any amendment that is required to be approved by the stockholders under Section 423 of the Code shall be submitted to the stockholders of the Company for approval. SECTION 5.07 Expiration and Termination of the Plan. The Plan shall continue in effect for ten years from the Effective Date, unless terminated prior to that date pursuant to the provisions of the Plan or pursuant to action by the Board of Directors. The Board of Directors shall have the right to terminate the Plan at any time without prior notice to any Participant and without liability to any Participant. Upon the expiration or termination of the Plan, the balance, if any, then standing to the credit of each Participant from amounts withheld from the Participant's Compensation or deposited by the Participant which has not, by such time, been applied to the purchase of Stock shall be refunded to the Participant.
SECTION 5.08 No Employment Rights. Participation in the Plan shall not give an employee any right to continue in the employment of an Employer, and shall not affect the right of the Employer to terminate the employee's employment at any time, with or without cause. SECTION 5.09 Repurchase of Stock. The Company shall not be required to purchase or repurchase from any Participant any of the shares of Stock that the Participant acquires under the Plan. SECTION 5.10 Notice. A Purchase Agreement and any notice that a Participant files pursuant to the Plan shall be on the form prescribed by the Committee and shall be effective only when received by the Committee. Delivery of such forms may be made by hand or by certified mail, sent postage prepaid, to the Company's corporate headquarters, or such other address as the Committee may designate. Delivery by any other mechanism shall be deemed effective at the option and discretion of the Committee. SECTION 5.11 Government Regulation. The Company's obligation to sell and to deliver the Stock under the Plan is at all times subject to all approvals of any governmental authority required in connection with the authorization, issuance, sale or delivery of such Stock. SECTION 5.12 Internal Revenue Code and ERISA Considerations. The Plan is intended to constitute an "employee stock purchase plan" within the meaning of Section 423 of the Internal Revenue Code of 1986, as amended. The Plan is not intended and shall not be construed as constituting an "employee benefit plan," within the meaning of Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended. SECTION 5.13 Headings, Captions, Gender. The headings and captions herein are for convenience of reference only and shall not be considered as part of the text. The masculine shall include the feminine, and vice versa. SECTION 5.14 Severability of Provisions, Prevailing Law. The provisions of the Plan shall be deemed severable. In the event any such provision is determined to be unlawful or unenforceable by a court of competent jurisdiction or by reason of a change in an applicable statute, the Plan shall continue to exist as though such provision had never been included therein (or, in the case of a change in an applicable statute, had been deleted as of the date of such change). The Plan shall be governed by the laws of the Commonwealth of Pennsylvania to the extent such laws are not in conflict with, or superseded by, federal law. * * * * * * * * * * *
EXHIBIT 10.40 AQUA AMERICA, INC. 2004 EQUITY COMPENSATION PLAN STOCK OPTION AND DIVIDEND EQUIVALENT GRANT This Incentive Stock Option and Dividend Equivalent Grant Agreement evidences the grant made by Aqua America, Inc., a Pennsylvania corporation (the "Corporation"), to XX, an officer of the Corporation or one of its subsidiaries (the "Grantee"), under the terms and provisions of the Aqua America, Inc. 2004 Equity Compensation Plan (the "Plan"). WHEREAS, on March 18, 2004 the Executive Committee of the Board of Directors of the Corporation (the "Board") adopted the Plan, subject to the approval of the shareholders of the Corporation; WHEREAS, the Plan was approved and ratified at the Corporation's 2004 Annual Meeting of the Shareholders by the vote of the holders of a majority of the Corporation's common stock (the "Common Stock") entitled to vote thereon; WHEREAS, the Plan has been amended or amended and restated from time to time with the approval of the Corporation's Board of Directors and, when required, the Corporation's shareholders; WHEREAS, pursuant to the Plan, the Board has empowered its compensation committee (the "Committee") to grant options to purchase Common Stock and to grant dividend equivalents based upon the dividends earned on Common Stock (collectively, the "Grants") to eligible persons in accordance with the terms and provisions of the Plan; and WHEREAS, the Committee, as required by the Plan, considers the Grantee to be an eligible person as contemplated by the Plan and has determined that it would be in the best interests of the Corporation to make the Grants referred to herein; NOW, THEREFORE, the parties hereto, intending to be legally bound hereby, agree as follows: 1
1. Grant of Option. a. Number of Shares, Option Price and Exercise Schedule. Subject to the terms and conditions hereinafter set forth, the Corporation, with the approval and at the direction of the Committee, hereby grants to the Grantee an option to purchase an aggregate of XX shares of Common Stock at a price of $XX.XX per share. This option shall become exercisable in three (3) annual installments, the Grantee having the right hereunder to purchase from the Corporation, on and after the following dates, the following numbers of shares of Common Stock: ________________: XX SHARES, ________________: AN ADDITIONAL XX SHARES, ________________: AN ADDITIONAL XX SHARES; The right of the Grantee to purchase shares of Common Stock subject to any accrued installment may be exercised in whole or in part from time to time, subject to the restrictions set forth herein. The Committee may, in its sole discretion, accelerate the time at which the option may be exercised in whole or in part. Notwithstanding any determinations by the Committee regarding the exercise period of the option or the exercise schedule set forth above, all outstanding options shall become immediately exercisable upon a Change of Control of the Corporation (as defined in the Plan). b. Options as an Incentive Stock Option. It is intended that this option shall meet the applicable requirements of, and qualify as, an incentive stock option under the terms of Section 422 of the Internal Revenue Code as now or hereafter constituted (the "Code") and as interpreted by relevant rulings, regulations and other applicable authority, and shall in all respects be so interpreted and construed. In conformance with the foregoing, the Grantee understands and hereby acknowledges that: (i) in the event that the aggregate fair market value (determined at the time the option is granted) of the stock with respect to which incentive stock options are exercisable for the first time by the Grantee during any calendar year (under all stock option plans of the Corporation and its parents and subsidiaries, if any) exceeds $100,000, then to the extent of such excess, all or a portion of this option shall (if, and to the extent, required by Section 422 of the Code) not be treated as an incentive stock option; and (ii) any exercise of this option following the termination of employment of the Grantee which occurs more than three months from the date of such termination (including termination of employment on account of retirement, but excluding termination on account of death), or more than one year from the date of such termination in the case of total disability, will not satisfy the conditions of Section 422 of the Code for treatment as an incentive stock option; and (iii) therefore, any such excess referred to in (i), or exercise referred to in (ii), will be taxed in accordance with the rules of taxation governing the exercise of nonqualified stock options. Unless the Grantee could otherwise transfer Common Stock issued pursuant to an incentive stock option granted hereunder without incurring liability under Section 16(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), at least six months must elapse from the date of grant of an incentive stock option to the date of disposition of the Common Stock issued upon exercise of such option. c. Termination of Option. This option and all rights hereunder, to the extent such rights shall not have been exercised, shall terminate and become null and void after the expiration of ten (10) years from the Date of Grant (the "option term"). The Date of Grant for the options granted hereunder is [GRANT DATE]. 2
Upon the termination of the Grantee's employment for any reason (except as a result of retirement, disability or death), this option shall terminate. Notwithstanding the fact that, in all cases, the Grantee's employment shall be deemed to have terminated upon the sale of a subsidiary of the Corporation that employs the Grantee, the Committee, in its sole discretion, may extend the period during which the option may be exercised after such sale to the earliest of (i) a date which is not more than three years from the date of the sale of the subsidiary, (ii) the date of the Grantee's termination of employment with the subsidiary (or successor employer) following such sale for reasons other than retirement, disability or death, (iii) the date which is one year from the date of the Grantee's termination of employment with the subsidiary on account of the Grantee's total disability (as defined in Section 22(e)(3) of the Code), or three months from the date of such termination if on account of retirement or a disability other than a total disability, or (iv) the expiration of the original term of the option as established in the first paragraph of this Section. The Committee, in its sole discretion, may similarly extend the period of exercise of the option if the Grantee's employment with the Corporation is terminated in connection with the sale of a subsidiary of the Corporation. Upon termination of the Grantee's employment as a result of retirement, disability or death, the period during which any option that is exercisable as of the date of Grantee's termination of employment may be exercised shall not exceed: (i) one year from the date of such termination of employment in the case of death, (ii) two years from the date of such termination in the case of permanent and total disability (within the meaning of Section 22(e)(3) of the Code) or retirement; and (iii) three months from the date of such termination of employment in the case of other disability; but in no event shall the period extend beyond the expiration of the option term. Stock options that are not exercisable as of the termination of the Grantee's employment as a result of retirement, disability or death shall terminate as of the date of the Grantee's termination of employment. Subject to the foregoing, in the event of the Grantee's death, such option may be exercised by the Grantee's legal representative but only to the extent exercisable by Grantee as of the date of death. Notwithstanding the foregoing, the Committee, in its sole discretion, may determine that installments that are not exercisable as of the date of the Grantee's death, termination of employment on account of permanent and total disability (within the meaning of Section 22(e)(3) of the Code) or other termination of employment may also be exercised by the Grantee or in the case of death, the Grantee's legal representative or beneficiary. Grantee's transfer of employment among the Corporation, its parent or any subsidiary shall not be deemed to be a termination of employment. d. Forfeiture of Option. Notwithstanding any other provisions set forth herein or in the Plan, if the Grantee shall (i) commit any act of malfeasance or wrongdoing affecting the Corporation, any parent or subsidiary, (ii) breach any covenant not to compete, or employment contract, with the Corporation, any parent or subsidiary, or (iii) engage in conduct that would warrant the Grantee's discharge for cause (excluding general dissatisfaction with the performance of the Grantee's duties, but including any act of disloyalty or any conduct clearly tending to bring discredit upon the Corporation, any parent or subsidiary) this option, or the unexercised portion thereof, shall immediately terminate and be void. 3
e. Exercise Procedures. The Grantee may exercise this option with respect to all or any part of the whole number of shares then subject to exercise. Such exercise shall be effected as follows: Grantee shall deliver to the Committee written notice of intent to exercise. Such notice shall specify the number of shares as to which this option is to be exercised and the date of exercise thereof, which date shall be at least five (5) days after the delivery of such notice unless an earlier time shall have been mutually agreed upon. Such notice may instruct the Corporation to deliver shares of Common Stock due upon the exercise of the option to any registered broker or dealer in lieu of delivery to the Grantee. Such instructions must designate the account into which the shares are to be deposited. The Grantee may tender this notice of exercise, which has been properly executed by the Grantee, and the aforementioned delivery instructions to any broker or dealer. Full payment by the Grantee of the option price for the shares purchased shall be made on or before the date of issuance of the shares being purchased in cash, or, with the prior written consent of the Committee, in whole or in part through the surrender of shares of Common Stock (including without limitation shares of Common Stock acquired pursuant to the option then being exercised) at their fair market value as determined pursuant to the terms of the Plan. On the exercise date specified in the Grantee's notice or as soon thereafter as is practicable, the Corporation shall, without transfer or issue tax or other incidental expense to the Grantee, cause to be delivered to the Grantee a certificate or certificates for such shares out of theretofore unissued shares or reacquired shares, as the Corporation may elect, upon payment for the shares. The Corporation shall, without transfer or issue tax or other incidental expense to the Grantee, cause to be delivered to the Grantee separate certificates for those shares which will be treated as being issued pursuant to the exercise of an incentive stock option and for those shares, if any, which under Section 2 of the Agreement will be treated as being issued pursuant to the exercise of an option which is not an incentive stock option. The Corporation shall identify in its stock transfer records which shares are being issued pursuant to the exercise of an incentive stock option and which shares are being issued pursuant to the exercise of an option which is not an incentive stock option. 2. Dividend Equivalents. a. Number of Dividend Equivalents. Subject to the terms and conditions hereinafter set forth, the Corporation, with the approval and at the direction of the Committee, hereby grants to the Grantee XX dividend equivalents. The amount of dividend equivalents (the "Dividend Equivalent Amount") subject to this grant shall be equal to the number of dividend equivalents specified in this Section 2.a. multiplied by the per-share cash dividend, or the per-share fair market value (as determined by the Committee) of any dividend in other than cash, paid by the Corporation on each record date for the payment of a dividend during the period described in Section 2.b. b. Amount of Dividend Equivalent Credited. The Corporation shall credit to an account for the Grantee maintained by the Corporation in its books and records on each record date, from the Date of Grant until the earlier of (i) the date of the Grantee's termination of employment for any reason (including retirement), other than total disability (as defined in Section 22(e)(3) of the 4
Code) or the Grantee's death, or as otherwise determined by the Committee, in its sole discretion, at the time of the Grantee's termination of employment or (ii) four years from the Date of Grant (such period being hereinafter referred to as the "Accumulation Period"), that portion of the Dividend Equivalent Amount for the Grantee attributable to such record date. The Corporation shall maintain in its books and records separate accounts which identify each grantee's Dividend Equivalent Amount. Except as set forth in Section 2.g. below, no interest shall be credited to any such account. The Date of Grant for the dividend equivalents granted hereunder is <
>. c. Payment of Credited Dividend Equivalents. At the end of the applicable performance period (the "Performance Period"), 100% of the Grantee's Dividend Equivalent Amount shall be paid to the Grantee. The Performance Period shall be equal to four years from the Date of Grant; provided, however, that such Performance Period shall be: (i) reduced by one year for each calendar year during the applicable Performance Period ending after the Date of Grant in which the measurable performance criteria set forth in Section 2.d. of the Agreement for the applicable Performance Period exceeds the targets for such criteria. (ii) increased by one year for each calendar year during the applicable Performance Period ending after the Date of Grant in which the measurable performance criteria set forth in Section 2.d. for the applicable Performance Period is less than the targets for such criteria. (iii) In no event shall the Performance Period be reduced to less than two years or increased to more than eight years from the Date of Grant. (iv) In the event that the Performance Period is shorter than the Accumulation Period described in Section 2.b., the Grantee shall receive the payment of the amount credited to his account at the end of the applicable Performance Period and any portion of the Dividend Equivalent Amount attributable to a dividend record date between the end of the Performance Period and the end of the Accumulation Period shall be paid on the Corporation's normal dividend payment dates until the Grantee's Dividend Equivalent Amount for the period described in Section 2(b) is fully paid to the Grantee. d. Performance Criteria. The performance criteria applicable to the Performance Period for the dividend equivalents granted hereunder shall be as set forth in Exhibit A attached hereto and made a part hereof. e. Timing of Payment of Dividend Equivalents. Except as otherwise determined by the Committee, if the Grantee terminates from employment prior to the end of the applicable Performance Period, no payments of the Dividend Equivalent Amount shall be made until the end of the applicable Performance Period and no payments shall be made to the Grantee if the Grantee's employment with the Corporation or a subsidiary terminates prior to the end of the applicable Performance Period for any reason other than retirement under the Corporation's or a subsidiary's retirement plan, death or total disability (as defined in section 22(e)(3) of the Code). Subject to Section 2.c.(iv), as soon 5 as practicable after the end of such Performance Period, unless the Grantee shall have made an election under Section 2(h) to defer receipt of any portion of such amount, the Grantee shall receive 100% of the Dividend Equivalent Amount payable to him. Notwithstanding the foregoing, upon a Change of Control of the Corporation (as defined in the Plan), any Dividend Equivalent Amount or portion thereof, which has not, prior to such date, been paid to the Grantee or forfeited shall immediately become payable to the Grantee without regard to whether the applicable Performance Period has ended. f. Form of Payment. The Committee shall have the sole discretion to determine whether the Corporation's obligation in respect of the payment of a Dividend Equivalent Amount shall be paid solely in credits to be applied toward payment of the option price under then exercisable options, solely in cash or partly in such credits and partly in cash. g. Interest on Dividend Equivalents. From a date which is 45 days after the end of the applicable Performance Period until the date that the Dividend Equivalent Amount payable to the Grantee is paid to the Grantee, the account maintained by the Corporation in its books and records with respect to such dividend equivalents shall be credited with interest at a market rate determined by the Committee. h. Deferral of Dividend Equivalents. The Grantee shall have the right to defer receipt of any Dividend Equivalent Amount payments if he shall elect to do so on or prior to December 31 of the year preceding the beginning of the last full year of the applicable Performance Period (or such other time as the Committee shall determine is appropriate to make such deferral effective under the applicable requirements of federal tax laws). The terms and conditions of any such deferral (including the period of time thereof and any earnings on the deferral) shall be subject to approval by the Committee and all deferrals shall be made on a form provided the Grantee for this purpose. 3. Adjustment of and Changes in Common Stock of the Corporation. In the event of a reorganization, recapitalization, change of shares, stock split, spin-off, stock dividend, reclassification, subdivision or combination of shares, merger, consolidation, rights offering, or any other change in the corporate structure or shares of the Corporation, the Committee may make such adjustment as it deems appropriate in the number and kind of shares subject to the Grants, the option price or other terms and conditions applicable to dividend equivalents. 4. No Rights of Shareholders. Neither the Grantee nor any personal representative shall be, or have any of the rights and privileges of, a shareholder of the Corporation with respect to any shares related to the Grants or purchasable upon the exercise of this option, in whole or in part, prior to the date of exercise of the option. 6
5. Non-Transferability of Grants. Except as otherwise provided in this Section, during the Grantee's lifetime, only the Grantee or any guardian or legal representative of the Grantee, may exercise rights under the Grants and the Grants shall not be assigned or transferred by the Grantee (other than an assignment pursuant to a qualified domestic order as defined under the Code or Title I of ERISA or the rules thereunder or transfer by will or by the laws of descent or distribution in the event of the death of the Grantee). Upon a transfer of an option granted hereunder by will or by the laws of descent or distribution, or a family transfer (as hereinafter provided), the person to whom the option is transferred shall have the right to exercise the option in accordance with the Plan and this Grant. The Grantee may transfer all or a portion of a nonqualified stock option granted hereunder to family members, one or more trusts for the benefit of family members, or one or more other entities of which family members control the management of assets or own more than 50% of the voting interests, consistent with applicable securities laws, provided that the Grantee receives no consideration for the transfer of the option and the transferred option shall continue to be subject to the same terms and conditions as were applicable to the option immediately before the transfer. In the event of any attempt by the Grantee (or assignee) to alienate, assign, pledge, hypothecate or otherwise dispose of a Grant or of any right hereunder, except as provided for herein, or in the event of the levy of any attachment, execution or similar process upon the rights or interest hereby conferred, the Corporation may terminate the Grant by notice to the Grantee and it shall thereupon become null and void. 6. Employment Not Affected. Neither the making of the Grants nor the exercise of the option or the payment of the Dividend Equivalent Amount shall be construed as granting to the Grantee any right with respect to continuance of employment by the Corporation or any of its subsidiaries. Except as may otherwise be limited by a written agreement between the Corporation or any subsidiary and the Grantee, the right of the Corporation or any parent or subsidiary to terminate at will the Grantee's employment with it at any time (whether by dismissal, discharge, or otherwise) is specifically reserved and acknowledged by the Grantee. 7. Withholding of Tax. Whenever shares of Common Stock are to be delivered upon exercise of the option, the Corporation shall be entitled to require as a condition of such delivery that the Grantee remit to the Grantee's employer or, in appropriate cases, agree to remit to such employer when due, an amount sufficient to satisfy all federal, state and local withholding tax requirements relating thereto. 7
8. Amendment of Grants. The Grants may be amended by the Committee at any time (i) if it determines, in its sole discretion, that amendment is necessary or advisable in the light of any addition to or change in the Internal Revenue Code or regulations issued thereunder, or any federal or state securities law or other law or regulation, which change occurs after the grant of the option and dividend equivalents and by its terms retroactively applies to the option or dividend equivalent; and (ii) with the consent of the Grantee. Any such amendment shall be in writing and signed by the Corporation and the Grantee. 9. Notice. Any notice to the Corporation provided for in this instrument shall be addressed to it in care of its Secretary, and any notice to the Grantee shall be addressed to the Grantee at the current address shown on the payroll of the Corporation or any subsidiary. Except as otherwise provided herein, any notice shall be deemed to be duly given if and when properly addressed and posted by registered or certified mail, postage prepaid. 10. Incorporation of Plan by Reference. The Grants are made pursuant to the terms of the Plan, as in effect on March 18, 2004, as approved by a majority of the Corporation's shareholders on May 20, 2004 and as the Plan may be amended from time to time, and shall in all respects be interpreted in accordance therewith. The Committee shall interpret and construe the Grants, and its decision shall be conclusive and binding upon any questions arising hereunder. By executing this Grant Agreement and by accepting the option granted hereunder, the Grantee acknowledges and accepts the terms of the Plan and the Committee's authority and discretion as specified in the Plan. 11. Governing Law. The validity, construction, interpretation and effect of this instrument shall exclusively be governed by and determined in accordance with the law of the Commonwealth of Pennsylvania. AQUA AMERICA, INC. By:______________________________ By:________________________________ Grantee 8
EXHIBIT 13.1 AQUA AMERICA, INC. SELECTED PORTIONS OF ANNUAL REPORT TO SHAREHOLDERS FOR THE YEAR ENDED DECEMBER 31, 2005
AQUA AMERICA, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations (In thousands of dollars, except per share amounts) FORWARD-LOOKING STATEMENTS This report by Aqua America, Inc. ("Aqua America," "we" or "us") contains, in addition to historical information, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks, uncertainties and other factors, that may be outside our control and that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. In some cases you can identify forward-looking statements where statements are preceded by, followed by or include the words "believes," "expects," "anticipates," "plans," "future," "potential" or the negative of such terms or similar expressions. Forward-looking statements in this report, include, but are not limited to, statements regarding: o recovery of capital expenditures and expenses in rates; o projected capital expenditures and related funding requirements; o dividend payment projections; o future financing plans; o future pension contributions; o opportunities for future acquisitions, the success of pending acquisitions and the impact of future acquisitions; o acquisition-related costs and synergies; o the capacity of our water supplies, water facilities and wastewater facilities; o general economic conditions; o the impact of geographic diversity on our exposure to unusual weather; and o the impact of accounting pronouncements. Because forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including but not limited to: o changes in general economic, business and financial market conditions; o changes in government regulations and policies, including environmental and public utility regulations and policies; o changes in environmental conditions, including those that result in water use restrictions; o abnormal weather conditions; o changes in, or unanticipated, capital requirements; o changes in our credit rating; o our ability to integrate businesses, technologies or services which we may acquire; o our ability to manage the expansion of our business; o the extent to which we are able to develop and market new and improved services; o the effect of the loss of major customers; o our ability to retain the services of key personnel and to hire qualified personnel as we expand; o increasing difficulties in obtaining insurance and increased cost of insurance; o cost overruns relating to improvements or the expansion of our operations; o changes in accounting pronouncements; and o civil disturbance or terroristic threats or acts. Given these uncertainties, you should not place undue reliance on these forward-looking statements. You should read this report with the understanding that our actual future results may be materially different from what we expect. These forward-looking statements represent our estimates and assumptions only as of the date of this report. Except for our ongoing obligations to disclose material information under the federal securities laws, we are not obligated to update these forward-looking statements, even though our situation may change in the future. We qualify all of our forward-looking statements by these cautionary statements. As you read this report, you should pay particular attention to the "Risk Factors" included in our Annual Report on Form 10-K. 1
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) OVERVIEW THE COMPANY Aqua America, Inc. is the holding company for regulated utilities providing water or wastewater services to approximately 2.5 million people in Pennsylvania, Ohio, North Carolina, Illinois, Texas, New Jersey, Florida, Indiana, Virginia, Maine, Missouri, New York and South Carolina. Our largest operating subsidiary, Aqua Pennsylvania, Inc., accounts for approximately 56% of our operating revenues for 2005 and, as of December 31, 2005, provides water or wastewater services to approximately one-half of the total number of people we serve, located in the suburban areas north and west of the City of Philadelphia and in 22 other counties in Pennsylvania. Our other subsidiaries provide similar services in 12 other states. In addition, we provide water and wastewater service through operating and maintenance contracts with municipal authorities and other parties close to our operating companies' service territories. We are the largest U.S.-based publicly-traded water utility based on number of people served. INDUSTRY MISSION The mission of the investor-owned water utility industry is to provide quality and reliable water service at an affordable price for the customer with a fair return for shareholders. A number of challenges face the industry, including: o strict environmental, health and safety standards; o the need for substantial capital investment; o economic regulation by state, and/or, in some cases, local government; and o the impact of weather and drought conditions on water sales demand. RATE CASE MANAGEMENT CAPABILITY We strive to achieve the industry mission by effective planning and efficient use of our resources. We maintain a rate case management capability to pursue timely and adequate returns on the capital investments that we make in improving or replacing water mains, treatment plants and other infrastructure. This capability is important in our continued profitability and in providing a fair return to our shareholders, and thus providing access to capital markets to help fund these investments. Often these utility investments are required by a changed federal or state environmental standard, to improve our ability to deliver quality customer service, or to assist in our ability to supply water in sufficient quantities for future demand or when experiencing drought conditions. ECONOMIC REGULATION - Most of our water and wastewater utility operations are subject to regulation by their respective state regulatory commissions, which have broad administrative power and authority to regulate rates and charges, determine franchise areas and conditions of service, approve acquisitions and authorize the issuance of securities. The regulatory commissions also establish uniform systems of accounts and approve the terms of contracts with affiliates and customers, business combinations with other utility systems, loans and other financings, and the franchise areas that we serve. A small number of our operations are subject to rate regulation by county or city government. The profitability of our utility operations is influenced to a great extent by the timeliness and adequacy of rate allowances in the various states in which we operate. Accordingly, we maintain a rate case management capability to provide that the tariffs of the utility operations reflect, to the extent practicable, the timely recovery of increases in costs of operations, capital, taxes, energy, materials and compliance with environmental regulations. In assessing our rate case strategy, we consider the amount of utility plant additions and replacements made since the previous rate decision, the changes in the cost of capital, changes in the capital structure and changes in other costs. Based on these assessments, our utility operations periodically file rate increase requests with their respective state regulatory commissions. Some of the states in which we acquired operations in 2004 and 2003 require separate filings for each of our local systems, as compared to a single state-wide rate filing. Between August 2003 and December 2005, we have filed rate filings in over 25 jurisdictions. Due to the length of time since the last rate increase for some acquired systems and the large amount of capital improvements relative to the number of customers in some smaller systems, the proposed rate increase in some of these systems may be substantial. While each of these rate filings will proceed through the applicable regulatory process, we can provide no assurance that the rate increases will be granted in a timely or sufficient manner to cover the investments and expenses for which we initially sought the rate increases. Further, there remain 116 divisions within these recently acquired operations where we have not yet filed a rate request. 2
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) REVENUE SURCHARGES - Five states in which we operate permit water utilities, and in some of these five states, wastewater utilities, to add a surcharge to their water or wastewater bills to offset the additional depreciation and capital costs associated with certain capital expenditures related to replacing and rehabilitating infrastructure systems. In all other states, water and wastewater utilities absorb all of the depreciation and capital costs of these projects between base rate increases without the benefit of additional revenues. The gap between the time that a capital project is completed and the recovery of its costs in rates is known as regulatory lag. The infrastructure rehabilitation surcharge mechanism is intended to substantially reduce regulatory lag, which often acts as a disincentive to water and wastewater utilities to rehabilitate their infrastructure. In addition, certain states permit our subsidiaries to use a surcharge or credit on their bill to reflect certain allowable changes in costs until such time as these costs are fully incorporated in base rates. EFFECTS OF INFLATION - As a regulated enterprise, our rates are established to provide recovery of costs and a return on our investment. Recovery of the effects of inflation through higher water rates is dependent upon receiving adequate and timely rate increases. However, rate increases are not retroactive and often lag increases in costs caused by inflation. During periods of moderate to low inflation, as has been experienced for the past several years, the effects of inflation on our operating results are not significant. CUSTOMER AND BUSINESS SERVICES PROJECTS - We are currently consolidating our customer service locations into three principal call centers, implementing a common customer information system, and upgrading our financial information systems. We expect to complete our primary customer service initiatives by the end of 2006. Consistent with prior practice, we have capitalized costs and services associated with these projects and expect to recover these costs in future rates. Certain information technology costs associated with these projects, such as software training, data conversion and business process reengineering costs, have been deferred in accordance with SFAS No. 71. Although we believe it is probable that the applicable public utility commissions will allow recovery of these costs, we can provide no assurances as to their full recoverability until the conclusion of the applicable rate proceeding. As of December 31, 2005, $3,952 of costs have been incurred and deferred as a regulatory asset since the last rate proceeding, and $251 has been expensed during the year ended December 31, 2005, in the jurisdictions where future recovery is unlikely. GROWTH-THROUGH-ACQUISITION STRATEGY Part of our strategy to meet the industry challenges is to actively explore opportunities to expand our utility operations through acquisitions of water and wastewater utilities either in areas adjacent to our existing service areas or in new service areas. This growth-through-acquisition strategy allows us to operate more efficiently and provides an important source for possible future growth. The ability to successfully execute this strategy and meet the industry challenges is largely due to our qualified and trained workforce, which we strive to retain by treating employees fairly and providing our employees with development and growth opportunities. Please refer to the section captioned "Acquisitions" for an additional discussion of acquisitions. We believe that acquisitions will continue to be an important source of growth for us. With approximately 50,000 community water systems in the U.S., 84% of which serve less than 3,300 customers, the water industry is the most fragmented of the major utility industries (telephone, natural gas, electric, water and wastewater). In the states where we operate, we believe there are over 22,000 public water systems of widely varying size, with the majority of the population being served by government-owned water systems. Although not as fragmented as the water industry, the wastewater industry in the U.S. also presents opportunities for consolidation. According to the U.S. Environmental Protection Agency's (EPA) most recent survey of publicly-owned wastewater treatment facilities in 2000, there are approximately 16,000 such facilities in the nation serving approximately 72% of the U.S. population. The remaining population represents individual homeowners with their own treatment facilities; for example, community on-lot disposal systems and septic tank systems. The vast majority of wastewater facilities are government-owned rather than privately-owned. The EPA survey also indicated that there are approximately 6,600 wastewater facilities in operation or planned in the 13 states where we operate. 3
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) Because of the fragmented nature of the water and wastewater utility industries, we believe that there are many potential water and wastewater system acquisition candidates throughout the United States. We believe the factors driving the consolidation of these systems are: o the benefits of economies of scale; o increasingly stringent environmental regulations; o the need for capital investment; and o the need for technological and managerial expertise. We are actively exploring other opportunities to expand our water and wastewater utility operations through acquisitions or otherwise. We intend to continue to pursue acquisitions of municipally-owned and investor-owned water and wastewater systems of all sizes that provide services in areas adjacent to our existing service territories or in new service areas. SENDOUT "Sendout" represents the quantity of treated water delivered to our distribution systems. We use sendout as an indicator of customer demand. Weather conditions tend to impact water consumption, particularly in our northern service territories during the late spring and summer months when nonessential and recreational use of water is at its highest. Consequently, a higher proportion of annual operating revenues is realized in the second and third quarters. In general during this period, an extended period of dry weather increases water consumption, while above average rainfall decreases water consumption. Also, an increase in the average temperature generally causes an increase in water consumption. Conservation efforts, construction codes which require the use of low flow plumbing fixtures, as well as mandated water use restrictions in response to drought conditions, also affect water consumption. The geographic diversity of our customer base helps reduce our exposure to extreme or unusual weather conditions in any one area of our service territory. Our geographic diversity has continued to widen as a result of the Heater and Florida Water acquisitions which closed in mid-year 2004 and the AquaSource acquisition which closed in 2003. During the year ended December 31, 2005, our operating revenues were derived principally from the following states: 56% in Pennsylvania, 8% in Ohio, 8% in Texas, 7% in Illinois, and 6% in North Carolina. On occasion, drought warnings and water use restrictions are issued by governmental authorities for portions of our service territories in response to extended periods of dry weather conditions. The timing and duration of the warnings and restrictions can have an impact on our water revenues and net income. In general, water consumption in the summer months is affected by drought warnings and restrictions to a higher degree because nonessential and recreational use of water is highest during the summer months, particularly in our northern service territories. At other times of the year, warnings and restrictions generally have less of an effect on water consumption. 4
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) SELECTED FINANCIAL AND OPERATING STATISTICS Our selected five-year financial and operating statistics follow: Years ended December 31, 2005 2004 (a) 2003 (b) 2002 (c) 2001 - ------------------------------------------------------------------------------------------------------------------ Customers: Residential water 724,954 702,367 624,355 535,506 526,776 Commercial water 33,975 33,720 33,015 30,355 29,745 Industrial water 1,356 1,365 1,397 1,423 1,454 Other water 15,584 15,700 20,483 16,466 9,947 Wastewater 89,025 82,360 70,241 21,724 19,615 - ------------------------------------------------------------------------------------------------------------------ Total 864,894 835,512 749,491 605,474 587,537 ================================================================================================================== Operating revenues: Residential water $295,473 $264,910 $218,487 $197,190 $188,303 Commercial water 73,455 65,605 61,343 55,962 53,103 Industrial water 18,364 17,377 17,675 17,221 16,141 Other water 50,827 44,593 40,048 36,255 35,681 Wastewater 42,176 35,931 17,874 8,210 6,960 Other 16,484 13,623 11,806 7,190 7,092 - ------------------------------------------------------------------------------------------------------------------ Total $496,779 $442,039 $367,233 $322,028 $307,280 ================================================================================================================== Operations and maintenance expense $203,088 $178,345 $140,602 $117,735 $111,885 ================================================================================================================== Net income available to common stock $91,156 $80,007 $70,785 $67,154 $60,005 ================================================================================================================== Capital expenditures $237,462 $195,736 $163,320 $136,164 $124,088 ================================================================================================================== Operating Statistics Selected operating results as a percentage of operating revenues: Operations and maintenance 40.9% 40.3% 38.3% 36.6% 36.4% Depreciation and amortization 13.2% 13.3% 14.0% 13.8% 13.1% Taxes other than income taxes 6.4% 6.2% 5.9% 6.0% 6.8% Interest expense, net 10.4% 11.0% 12.2% 12.5% 11.9% Net income available to common stock 18.3% 18.1% 19.3% 20.9% 19.5% ================================================================================================================== Effective tax rates 38.4% 39.4% 39.3% 38.5% 39.3% ================================================================================================================== (a) Net income available to common stock includes the gain of $1,522 ($2,342 pre-tax) realized on the sale of our Geneva, Ohio water system. The gain is reported in the 2004 consolidated statement of income as a reduction to operations and maintenance expense. 2004 includes a partial year of financial results for the mid-year acquisition of Heater Utilities, Inc. and certain utility assets of Florida Water Services Corporation. (b) 2003 includes five months of financial results for the AquaSource operations acquired in July 2003. (c) Net income available to common stock and net income includes the gain of $3,690 ($5,676 pre-tax) realized on the sale of a portion of our Ashtabula, Ohio water system. 5
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) PERFORMANCE MEASURES CONSIDERED BY MANAGEMENT We consider the following nonfinancial measure and financial measures to be the fundamental basis by which we evaluate our performance: our number of customers, operating revenues, net income and dividend rate on common stock. In addition, we consider other key financial measures in evaluating our operating results: earnings per share, the ratio of operations and maintenance expense compared to operating revenues (this percentage is termed "operating expense ratio" or "efficiency ratio"); return on revenues (net income divided by operating revenues); and return on equity (net income divided by common stockholders' equity). We review these measurements regularly and compare them to historical periods as well as our operating budget as approved by the Aqua America, Inc. Board of Directors. Our operating expense ratio is one measure that we use to evaluate our operating efficiency and management effectiveness. As reported in the table above, and as anticipated, our operating expense ratio increased for 2004 over 2003, and increased for 2003 over 2002 as a result of the additional operating costs associated with the AquaSource acquisition which closed in July 2003. Our 2004 results reflect a full twelve months of operating results for the acquisition, while our 2003 results reflect only five months of operating results for the acquisition. The business model of the acquired AquaSource operations, generally referred to as our Aqua South operations, is different from the rest of the Aqua America operations. The Aqua South operations are comprised of approximately 600 small systems, which are generally clustered in regions to achieve some level of operating efficiency. The small, separate systems of the Aqua South operations result in the operating revenues generated by the Aqua South operations being accompanied by a higher ratio of operations and maintenance expenses as compared to the rest of the pre-existing Aqua America operations. The Aqua South operations can be characterized as having relatively-higher fixed operating costs, in contrast to the rest of the Aqua America operations which generally consist of larger, interconnected systems, resulting in higher fixed capital costs (utility plant investment) and lower operating costs per customer. For the twelve-month period ended June 30, 2003, the last reporting period before the July 31, 2003 closing of AquaSource, our operating expense ratio declined to 36.5%, from 36.6% for the year ended December 31, 2002. To a lesser extent, the 2005 and 2004 efficiency ratios increased over the previous years due to the influence of the mid-year 2004 acquisitions of Heater Utilities, Inc. and Florida Water Services Corporation, which have similar operating characteristics as our Aqua South operations. Our efficiency ratio in 2004 was reduced by approximately 53 basis-points for a $2,342 gain realized on the sale of our Geneva, Ohio water system that was reported in the 2004 consolidated statement of income as a reduction to operations and maintenance expense. Other factors that influence the efficiency ratio include regulatory lag, i.e., changes in operations and maintenance expenses without an immediate corresponding change in operating revenues, and operating revenues when accompanied by a dissimilar change in operations and maintenance expense, such as changes in water consumption as impacted by weather conditions. On January 1, 2006, we adopted SFAS No. 123R, "Share-Based Payment." As required, we began to record compensation expense for the fair value of stock options granted and the adoption of this accounting standard is expected to increase our 2006 operations and maintenance expense by approximately $3,500. We continue to evaluate management initiatives to help control costs and improve efficiencies, but the effect of these acquisitions have been to increase our overall operating expense ratio from the levels experienced during the three years preceding the AquaSource acquisition. Consequently, our return on revenues in 2005 and 2004 was lower than 2003, 2002 and 2001 as a result of the impact of the higher cost of Aqua South's operations. 6
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) RESULTS OF OPERATIONS Our net income has grown at an annual compound rate of approximately 11.5% during the five-year period ended December 31, 2005. During the past five years, operating revenues grew at a compound rate of 12.6% and total expenses, exclusive of income taxes, grew at a compound rate of 12.8%. OPERATING REVENUES The growth in revenues over the past five years is a result of increases in both the customer base and in water rates. The number of customers increased at an annual compound rate of 8.9% in the past five years primarily as a result of acquisitions of water and wastewater systems, including the mid-year 2004 Heater and Florida Water Services acquisitions, and the AquaSource acquisition completed July 2003. Acquisitions made during the five-year period ended December 31, 2005 have provided water and wastewater revenues of approximately $114,176 in 2005, $87,919 in 2004 and $32,427 in 2003. Excluding the effect of acquisitions, our customer base increased at a five-year annual compound rate of 1.5%. Rate increases implemented during the past three years have provided additional operating revenues of approximately $25,500 in 2005, $15,800 in 2004 and $19,900 in 2003. In November 2005, our Pennsylvania operating subsidiary filed an application with the Pennsylvania Public Utility Commission (PAPUC) requesting a $38,800 or 14.4% increase in annual revenues. The application is currently pending before the PAPUC and a final determination is anticipated by August 2006. On August 5, 2004, the PAPUC granted our Pennsylvania operating subsidiary a $13,800 base rate increase. The rates in effect at the time of the filing included $11,200 in Distribution System Improvement Charges ("DSIC") or 5.0% above the prior base rates. Consequently, the total base rates increased by $25,000 and the DSIC was reset to zero. In May 2004, our operating subsidiary in Texas filed an application with the Texas Commission on Environmental Quality to increase rates by $11,920 over a multi-year period. The application seeks to increase annual revenues in phases and is accompanied by a plan to defer and amortize a portion of our depreciation, operating and other tax expense over a similar multi-year period, such that the impact on operating income approximates the requested amount during the first years that the new rates are in effect. The application is currently pending before the Commission and several parties have joined the proceeding to challenge our rate request. We commenced billing for the requested rates and implemented the deferral plan in August 2004, in accordance with authorization from the Texas Commission on Environmental Quality in July 2004. The additional revenue billed and collected prior to the final ruling are subject to refund based on the outcome of the ruling. The revenue recognized and the expenses deferred by us reflect an estimate of the final outcome of the ruling. As of December 31, 2005, we have deferred $9,486 of expenses and recognized $5,202 of revenue that is subject to refund based on the outcome of the final commission order, which is not expected to be issued prior to December 2006. In the event our request is denied completely or in part, we could be required to refund some or all of the revenue billed to date, and write-off some or all of the regulatory asset for the expense deferral. Based on our review of the present circumstances, no additional reserve or change in estimate adjustments are required for the revenue recognized to date or for the impairment of our regulatory asset. Our operating subsidiaries located in other states received rate increases representing estimated annualized revenues of $5,142 in 2005 resulting from twenty-three decisions, $6,673 in 2004 resulting from fourteen rate decisions, and $1,275 in 2003 resulting from eight rate decisions. Revenues from these increases realized in the year of grant were approximately $3,144 in 2005, $3,995 in 2004 and $839 in 2003. These operating subsidiaries currently have filed 18 rate requests which are being reviewed by the state regulatory commissions, proposing an aggregate increase of $9,202 in annual revenues. In addition, there were 14 rate awards received to date in 2006 for cases filed in 2005 in the amount of $1,961. During 2006, we intend to file 27 additional rate requests proposing an aggregate of approximately $17,029 of increased annual revenues. Currently, Pennsylvania, Illinois, Ohio, Indiana and Missouri allow for the use of infrastructure rehabilitation surcharges. In Pennsylvania, this mechanism is referred to as a DSIC. These surcharge mechanisms typically adjust periodically based on additional qualified capital expenditures completed or anticipated in a future period. The infrastructure rehabilitation surcharge is capped as a percentage of base rates, generally at 5% to 9% of base rates, and is reset to zero when new base rates that reflect the costs of those additions become effective or when a utility's earnings exceed a regulatory benchmark. Infrastructure rehabilitation surcharges provided revenues of $10,186 in 2005, $7,817 in 2004 and $8,147 in 2003. 7
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) In addition to regulated water and wastewater operating revenues, we had other non-regulated revenues that were primarily associated with operating and maintenance contracts, and data processing service fees of $16,484 in 2005, $13,623 in 2004 and $11,806 in 2003. The increase in 2005 over 2004 resulted primarily from the additional revenues associated with the acquisition of an on-site septic tank pumping business, and increased revenues resulting from new and expanded contract operations. The increase in 2004 over the previous year resulted primarily from the additional revenues from contract operations associated with the July 2003 AquaSource acquisition. OPERATIONS AND MAINTENANCE EXPENSES Operations and maintenance expenses totaled $203,088 in 2005, $178,345 in 2004 and $140,602 in 2003. Most elements of operating costs are subject to the effects of inflation, and changes in the number of customers served, and several elements are subject to the effects of changes in water consumption, weather and the degree of water treatment required due to variations in the quality of the raw water. The principal elements of operating costs are labor and employee benefits, electricity, chemicals, maintenance expenses and insurance costs. Electricity and chemical expenses vary in relationship to water consumption, raw water quality, and to a lesser extent the competitive electric market in some of the states in which we operate. Maintenance expenses are sensitive to extremely cold weather, which can cause water mains to rupture. Operations and maintenance expenses increased in 2005 as compared to 2004 by $24,743 or 13.9% primarily due to the additional operating costs associated with acquisitions of $9,574, additional water production expenses of $3,856, increased postretirement costs of $2,430, higher insurance costs due to the absence in 2005 of the favorable claim settlements that had occurred in 2004 of $2,142, and the effect of the $2,342 gain on the sale of the Geneva water system which was recorded as a component of operations and maintenance expense in 2004. Operations and maintenance expenses increased in 2004 as compared to 2003 by $37,743 or 26.8% primarily due to added operating costs associated with acquisitions of $36,123, additional postretirement costs of $2,110, increased accounting expense of $1,496 for assessing internal control effectiveness under the Sarbanes-Oxley Act and higher water production expenses. Partially offsetting these increases were lower insurance costs due to the favorable settlement of insurance claims during 2004, and the gain on the sale of the Geneva, Ohio water system of $2,342. In the consolidated statement of income for 2004, the gain on the sale of the Geneva water system is reported as a component of the line titled operations and maintenance expense. The impact of acquisitions is primarily the result of the effect of AquaSource for the full twelve-month period versus five months in 2003, and the mid-year 2004 acquisitions of Heater and the Florida Water Services systems. DEPRECIATION AND AMORTIZATION EXPENSES Depreciation expense was $60,747 in 2005, $54,564 in 2004 and $48,522 in 2003, and has increased principally as a result of the significant capital expenditures made to expand and improve our utility facilities, and as a result of acquisitions of water systems. Amortization expense was $4,741 in 2005, $4,300 in 2004 and $2,941 in 2003. The increase in 2005 and 2004 is due to the amortization of the costs associated with, and other costs being recovered in, various rate filings. Expenses associated with filing rate cases are deferred and amortized over periods that generally range from one to three years. TAXES OTHER THAN INCOME TAXES Taxes other than income taxes increased by $4,100 or 14.9% in 2005 as compared to 2004 and $5,989 or 27.7% in 2004 as compared to 2003. The increase in both 2005 and 2004 is due to additional taxes associated with acquisitions and increases in state and local taxes. The other taxes associated with acquisitions resulted from the effect of the July 2003 AquaSource acquisition for a twelve-month period in 2004 as compared to the five-month period in 2003, and the mid-year 2004 acquisitions of Heater Utilities and the systems of Florida Water. INTEREST EXPENSE, NET Net interest expense was $52,062 in 2005, $48,679 in 2004 and $44,662 in 2003. Interest income of $3,040 in 2005, $1,762 in 2004 and $395 in 2003 was netted against interest expense. Interest expense increased in 2005 and 2004 primarily as a result of higher levels of borrowings, offset partially by the effects of decreased interest rates on borrowings. The higher level of average borrowings in 2004 was used to finance the acquisition of AquaSource in mid-year 2003, the Heater and Florida Water acquisitions in mid-year 2004, and capital expenditures. Interest income increased in 2005 due to additional investment income earned in 2005 on the proceeds from the issuance of tax-exempt bonds 8
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) while being held by trustees pending completion of projects financed with the issues. Such interest income is capitalized by a reduction in our allowance for funds used during construction. Interest income increased in 2004 due to $532 of interest income in connection with the arbitration award related to the final purchase price for the AquaSource acquisition received in 2004 and additional interest income associated with acquisitions. Interest expense during 2005 was favorably impacted by a reduction in the weighted cost of long-term debt from 6.00% at December 31, 2004 to 5.74% at December 31, 2005. ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION The allowance for funds used during construction (AFUDC) was $2,447 in 2005, $2,304 in 2004 and $2,127 in 2003 and has varied over the years as a result of changes in the average balance of utility plant construction work in progress (CWIP), to which AFUDC is applied, and to changes in the AFUDC rate. The increase in 2005 is due to an increase in the average balance of CWIP to which AFUDC is applied, and additional AFUDC recorded as an adjustment in 2005 of $719 resulting from the identification in 2005 of a previously issued rate order which allowed the continuation of AFUDC on certain capital projects subsequent to being placed into utility service. This post-in-service AFUDC was not recognized in prior periods. These variances were partially offset by investment income earned during 2005, which reduced AFUDC. The increase in 2004 is due to an increase in the average balance of CWIP to which AFUDC is applied. GAIN ON SALE OF OTHER ASSETS Gain on sale of other assets totaled $1,177 in 2005, $1,272 in 2004 and $5,692 in 2003 and consisted of gains on land and marketable securities sales. Gain on sale of land totaled $1,177 in 2005, $869 in 2004 and $5,153 in 2003. Gain on sale of marketable securities totaled $403 in 2004 and $539 in 2003. INCOME TAXES Our effective income tax rate was 38.4% in 2005, 39.4% in 2004 and 39.3% in 2003. The changes in the effective tax rates in 2005 and 2004 are due to differences between tax deductible expenses and book expenses and the recognition in 2005 of the American Jobs Creation Act tax deduction for qualified domestic production activities that reduced our tax provision by approximately $740. SUMMARY Operating income was $196,507 in 2005, $177,234 in 2004 and $153,561 in 2003 and net income available to common stock was $91,156 in 2005, $80,007 in 2004 and $70,785 in 2003. Diluted income per share was $0.71 in 2005, $0.64 in 2004, and $0.59 in 2004. The changes in the per share income in 2005 and 2004 over the previous years were due to the aforementioned changes in income and impacted by a 2.8% increase in the average number of common shares outstanding during 2005 and a 5.6% increase in the average number of common shares outstanding during 2004, respectively. The increase in the number of shares outstanding in 2005 is primarily a result of the additional shares issued through our dividend reinvestment plan, employee stock purchase plan and equity compensation plan. The increase in the number of shares outstanding in 2004 is primarily a result of the additional shares issued in common share offerings and the aforementioned factors for 2005. Although we have experienced increased income in the recent past, continued adequate rate increases reflecting increased operating costs and new capital investments are important to the future realization of improved profitability. FOURTH QUARTER RESULTS Net income available to common stock was $22,150 in the fourth quarter of 2005 and $22,474 in the same period of 2004. The change in net income is due to increased operations and maintenance expense of $6,717, increased depreciation of $2,585 and increased other taxes of $1,522, offset partially by a $7,466 increase in operating revenues. The higher operations and maintenance expense is due primarily to the gain on the December 2004 sale of the Geneva water system of $2,342 which reduced operations and maintenance expense in 2004, additional operating cots associated with acquisitions, higher water production costs and increased postretirement costs. The increased depreciation expense reflects the utility plant placed in service since the fourth quarter of 2004. Other taxes increased due to higher property taxes and additional local taxes incurred in the fourth quarter of 2005. The increase in operating revenues was a result of additional revenues of $2,131 resulting from an increase in water rates granted to our operating subsidiaries, additional infrastructure rehabilitation surcharge revenue of $2,377, and the additional revenue from acquisitions. 9
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) FINANCIAL CONDITION CASH FLOW AND CAPITAL EXPENDITURES Net operating cash flow, dividends paid on common stock, capital expenditures, including allowances for funds used during construction, and expenditures for acquiring water and wastewater systems for the five years ended December 31, 2005 were as follows: - ------------------------------------------------------------------------------------------------ Net Operating Common Capital Acquisitions of Cash Flow Dividends Expenditures Utility Systems - ------------------------------------------------------------------------------------------------ 2001 $ 102,165 $ 34,234 $ 124,088 $ 9,517 2002 121,560 36,789 136,164 8,914 2003 143,373 39,917 163,320 192,331 2004 173,603 45,807 195,736 54,300 2005 199,674 51,139 237,462 11,633 - ------------------------------------------------------------------------------------------------ $ 740,375 $ 207,886 $ 856,770 $ 276,695 ================================================================================================ Included in capital expenditures for the five-year period are: expenditures for the modernization and replacement of existing treatment plants, new water mains and customer service lines, rehabilitation of existing water mains and hydrants, and water meters. During this five-year period, we received $52,619 of customer advances and contributions in aid of construction to finance new water mains and related facilities which are not included in the capital expenditures presented in the above table. In addition, during this period, we have made sinking fund contributions and repaid debt in the amount of $242,849, retired $1,760 of preferred stock, and have refunded $23,701 of customer advances for construction. Common dividends increased during the past five years as a result of an annual increase in the common dividends declared and paid and an increase in the number of shares outstanding during the period. Our planned 2006 capital program, exclusive of the costs of new mains financed by advances and contributions in aid of construction, is estimated to be $255,200 of which $64,790 is for infrastructure rehabilitation surcharge-qualified projects. Our planned capital program includes spending for infrastructure rehabilitation in response to the infrastructure rehabilitation surcharge mechanisms, and should these mechanisms be discontinued for any reason, which is not anticipated, we would re-evaluate the magnitude of our capital program. Our 2006 capital program, along with $24,645 of sinking fund obligations and debt maturities, and $93,626 of other contractual cash obligations, as reported in the section captioned "Contractual Obligations", is expected to be financed through internally-generated funds, our revolving credit facilities, the issuance of equity and the issuance of new long-term debt. Future utility construction in the period 2007 through 2010, including recurring programs, such as the ongoing replacement of water meters, water treatment plant upgrades, storage facility renovations, the rehabilitation of water mains and additional transmission mains to meet customer demands, exclusive of the costs of new mains financed by advances and contributions in aid of construction, is estimated to require aggregate expenditures of approximately $950,000. We anticipate that less than one-half of these expenditures will require external financing of debt and the additional issuance of common stock through our dividend reinvestment and stock purchase plans and possible future public equity offerings. We expect to refinance $115,166 of sinking fund obligations and debt maturities during this period as they become due with new issues of long-term debt. The estimates discussed above do not include any amounts for possible future acquisitions of water systems or the financing necessary to support them. Our primary source of liquidity is cash flows from operations, borrowings under various short-term lines of credit and other credit facilities, and customer advances and contributions in aid of construction. Our cash flow from operations, or internally-generated funds, is impacted by the timing of rate relief and water consumption. We fund our capital and acquisition programs through internally-generated funds, supplemented by short-term borrowings. Over time, we refinance our short-term borrowings with long-term debt and proceeds from the issuance of common stock. The ability to finance our future construction programs, as well as our acquisition activities, depends on our ability to attract the necessary external financing and maintain internally-generated funds. Rate orders permitting compensatory rates of return on invested capital and timely rate adjustments will be required by our operating subsidiaries to achieve an adequate level of earnings and cash flow to enable them to secure the capital they will need to operate and to maintain satisfactory debt coverage ratios. 10
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) ACQUISITIONS During the past five years, we have expended cash of $276,695 and issued 816,019 shares of common stock, valued at $8,781 at the time of the acquisition, related to the acquisitions of utility systems, primarily water utilities and some wastewater utilities. We included the operating results of these acquisitions in our consolidated financial statements beginning on the respective acquisition date. During 2005, we completed 30 acquisitions for $11,633 in cash and the issuance of 24,684 shares of common stock. The acquisitions completed in 2005 included both water and wastewater systems in seven of the states in which we operate. Pursuant to our strategy to grow through acquisitions, on June 1, 2004, we acquired the capital stock of Heater Utilities, Inc. for $48,000 in cash and the assumption of long-term debt of $19,219 and short-term debt of $8,500. The acquired operation provides water and wastewater service to over 50,000 water and wastewater customers primarily in the areas of suburban Raleigh, Charlotte, Gastonia and Fayetteville, North Carolina. For the fiscal year ended December 31, 2003, Heater had operating revenues of $19,489. The acquisition was accounted for as a purchase and accordingly, we recorded goodwill of $18,842. In 2004, as part of the North Carolina Utilities Commission approval process for this acquisition, the Commission approved a mechanism through which we could recover up to two-thirds of the goodwill through customer rates in the future upon achieving certain objectives. We intend to pursue these objectives to facilitate recognition of this premium in customer rates. However, there can be no assurance that we will be able to achieve these objectives and recover such amount of goodwill, if any. On June 30, 2004, we acquired certain utility assets of Florida Water Services Corporation, comprised of 63 water and wastewater systems located in central Florida for $14,747 in cash. In accordance with Florida Public Service Commission procedures, the acquisition was approved by the Commission and rate base was determined on December 20, 2005. Under the terms of the purchase agreement, the Commission's rate base determination will result in a reduction of the final purchase price that could be as much as approximately $2,000, which is not expected to result in the recognition of goodwill. The acquisition of Heater and the Florida Water Systems were initially funded by a portion of the proceeds from the issuance by Aqua America of an unsecured short-term note in May 2004. A portion of the short-term note was subsequently repaid by Aqua America with the proceeds from a November 2004 secondary equity offering, and a portion of the short-term note was refinanced through the February 2005 issuance of $30,000 of unsecured notes. In November 2004, we sold 2,606,667 shares of common stock in a public offering for proceeds of $42,600, net of expenses. In February 2005, Aqua America issued $18,000 of notes due in 2015 with an interest rate of 5.01% and $12,000 of notes due in 2020 with an interest rate of 5.20%. Pursuant to our growth strategy, in July 2003, we completed the acquisition of four operating water and wastewater subsidiaries of AquaSource, Inc., a subsidiary of DQE, Inc., including selected, integrated operating and maintenance contracts and related assets (individually and collectively the acquisition is referred to as "AquaSource") for $190,717 in cash, as adjusted pursuant to the purchase agreement based on working capital at closing. In August 2004, we were awarded and received $12,289 plus interest in an arbitration related to the calculation of the final purchase price under the terms of the purchase agreement, which resulted in a final purchase price of $178,428. In the consolidated statement of cash flow for 2004, the $12,289 award has been reported as proceeds on the line titled acquisitions of water and wastewater systems, net. The acquisition was initially funded by a portion of the proceeds from the July 2003 issuance of $135,000 of unsecured notes due 2023, with an interest rate of 4.87%, and the issuance of a $90,000 unsecured note by Aqua America. In August 2003, the $90,000 unsecured note was repaid with the proceeds from the issuance of 6,666,667 shares of common stock through a shelf registration. The acquired operations of AquaSource serve over 130,000 water and wastewater customer accounts in 11 states (including the Connecticut and Kentucky operations which were subsequently sold to other parties). Please refer to the section captioned "Dispositions" for a discussion of the AquaSource operations located in Connecticut and Kentucky. The acquisition provides an expanded platform from which to extend our growth-through-acquisition strategy of acquiring water and wastewater systems that are near or adjacent to our existing service territories. The AquaSource operations are comprised of approximately 600 small systems, which are generally clustered in regions to achieve some level of operating efficiency. We continue to hold acquisition discussions with several water and wastewater systems. Generally acquisitions are expected to be financed through the issuance of equity (for the acquisition of some investor-owned systems) or funded initially with short-term debt with subsequent repayment from the proceeds of long-term debt or proceeds from equity offerings. 11
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) DISPOSITIONS In December 2004, as a result of the settlement of a condemnation action, our Ohio operating subsidiary sold its water utility assets within the municipal boundaries of the City of Geneva in Ashtabula County, Ohio for net proceeds of approximately $4,716, which was in excess of the book value for these assets. The proceeds were used to pay-down short-term debt and the sale resulted in the recognition in the fourth quarter of 2004 of a gain on the sale of these assets, net of expenses, of $2,342. The gain is reported in the 2004 consolidated statement of income as a reduction to operations and maintenance expense. We continue to operate this water system for the City of Geneva under an operating contract that began upon the closing of the sale for a period through December 2006. These water utility assets represented less than 1% of Aqua America's total assets, and the total number of customers included in the water system sold represented less than 1% of our total customer base. We reviewed and evaluated areas of our business and operating divisions that were acquired in July 2003 with the AquaSource operations and have completed the following sale transactions of operating divisions acquired as part of the AquaSource transaction: o In July 2004, we sold our only operation in Kentucky. The sale price approximated our investment in this operation. The operation represented approximately 0.2% of the operations acquired from AquaSource, Inc. o In October 2003, we completed the sale of our only operation in Connecticut. The sale price of $4,000 approximated our investment in this operation. The operation represented approximately 2% of the operations acquired from AquaSource, Inc. In December 2002, as a result of the settlement of a condemnation action, our Ohio operating subsidiary sold to Ashtabula County, Ohio the water utility assets in the unincorporated areas of Ashtabula County and the area within the Village of Geneva on the Lake for net proceeds of $12,118, which was in excess of the book value for these assets. The proceeds were used to pay down short-term debt, and the sale resulted in the recognition in 2002 of a gain on the sale of these assets, net of expenses, of $5,676. We continue to operate this water system for Ashtabula County under a multi-year operating contract that expires in December 2008. The water utility assets sold represented less than 1% of our total assets, and the total number of customers included in the water system sold represented less than 1% of our total customer base. The City of Fort Wayne, Indiana has authorized the acquisition, by eminent domain or otherwise, of a portion of the utility assets of one of the operating subsidiaries that we acquired in connection with the AquaSource acquisition. We have challenged whether the City is following the correct legal procedures in connection with the City's attempted condemnation and we have challenged the City's valuation of this portion of our system. The portion of the system under consideration represents approximately 1% of our total customer base. While we continue to discuss this matter with officials from the City of Fort Wayne, we continue to protect our interests in this proceeding. We believe that we will be entitled to fair market value for our assets if they are condemned, and that the fair market value will be in excess of the book value for such assets. Despite these transactions, our strategy continues to be to acquire additional water and wastewater systems, to maintain our existing systems where there is a business or a strategic benefit, and to actively oppose unilateral efforts by municipal governments to acquire any of our operations. SOURCES OF CAPITAL Since net operating cash flow plus advances and contributions in aid of construction have not been sufficient to fully fund cash requirements, we issued approximately $659,214 of long-term debt and obtained other short-term borrowings during the past five years. During the past five years, the Trustees held an aggregate $64,664 of the proceeds from certain long-term debt issuances pending completion of the projects financed with the issues. At December 31, 2005, we had short-term lines of credit and other credit facilities of $217,000, of which $78,495 was available. Our short-term lines of credit and other credit facilities are either payable on demand or have a 364-day term. In December 2005, we filed a universal shelf registration with the SEC to allow for the potential future sale by us, from time to time, in one or more public offerings, of an indeterminant amount of our common stock, preferred stock, debt securities and other securities specified therein at indeterminant prices. No issuances have been completed to date under this shelf registration. During the last three years, we completed the following offerings of equity: 12
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) o In November 2004, we sold 2,606,667 shares of common stock in a public offering for proceeds of $42,600, net of expenses. The net proceeds were used to repay a portion of our short-term debt. The short-term debt was incurred by Aqua America in connection with the Heater and Florida Water acquisitions. o In August 2003, we sold 6,666,667 shares of common stock in a public offering for proceeds of $90,100, net of expenses. The net proceeds were used to repay an unsecured note of $90,000. The indebtedness was incurred by Aqua America in connection with the acquisition of the operations that were purchased from AquaSource, Inc. o In May 2003, we sold 2,491,667 shares of common stock in a public offering for proceeds of $33,100, net of expenses. The net proceeds were used to repay short-term debt, including the repayment of $22,000 of indebtedness incurred in connection with our repurchase of 2,017,700 shares of our common stock from affiliates of Veolia Environnement, S.A., formerly Vivendi Environnement, S.A., in October 2002. In addition, we have a shelf registration statement filed with the SEC to permit the offering from time to time of shares of common stock and shares of preferred stock in connection with acquisitions. During 2005, we issued 24,684 shares of common stock totaling $675 to acquire a water system. During 2004 and 2003, we did not issue any shares under the acquisition shelf registration. During 2002, we issued 238,219 shares of common stock totaling $2,745 to acquire water and wastewater systems. The balance remaining available for use under the acquisition shelf registration as of December 31, 2005 is 2,194,262 shares. We will determine the form and terms of any securities issued under these shelf registrations at the time of issuance. We offer a Dividend Reinvestment and Direct Stock Purchase Plan (Plan) that provides a convenient and economical way to purchase shares of Aqua America, Inc. Under the direct stock purchase portion of the Plan, shares are sold throughout the year. The dividend reinvestment portion of the Plan offers a 5% discount on the purchase of shares of common stock with reinvested dividends. As of the December 2005 dividend payment, holders of 16.7% of the common shares outstanding participated in the dividend reinvestment portion of the Plan. The shares issued under the Plan are either original issue shares or shares purchased by the Company's transfer agent in the open-market. During the past five years, we have sold 2,484,207 original issue shares of common stock for net proceeds of $35,711 through the dividend reinvestment portion of the Plan and we used the proceeds to invest in our operating subsidiaries, to repay short-term debt, and for general corporate purposes. OTHER CAPITAL TRANSACTIONS In May 2002, Veolia Environnement, S.A., formerly Vivendi Environnement, S.A., which through its affiliates (collectively "VE") owned approximately 16.8% of our outstanding common stock, advised us of its decision to sell its investment in Aqua America. VE announced that its decision was part of its overall strategy to divest non-core assets and focus on other business strategies. In September 2002, in order to facilitate the orderly re-distribution of the shares held by VE into the market, we completed a secondary offering of 16,475,427 shares of Aqua America common stock held by VE. The number of outstanding shares of common stock was not changed and we did not receive any proceeds as a result of this secondary offering. In addition, in October 2002 we repurchased 2,017,700 shares of Aqua America common stock representing the remainder of the shares of Aqua America common stock held by VE. The repurchase of shares was funded with proceeds of $22,000 from a short-term credit facility. In May 2003, this $22,000 short-term credit facility was repaid with funds from the issuance of 2,491,667 shares of common stock through a shelf registration, providing proceeds of approximately $33,100, net of expenses. The balance of the net proceeds were used to repay other short-term debt. The Board of Directors has authorized us to purchase our common stock, from time to time, in the open market or through privately negotiated transactions. We have not purchased any shares under this authorization since 2000. As of December 31, 2005, 548,278 shares remain available for repurchase. Funding for future stock purchases, if any, is not expected to have a material impact on our financial position. 13
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) OFF-BALANCE SHEET FINANCING ARRANGEMENTS We do not engage in any off-balance sheet financing arrangements. We do not have any interest in entities referred to as variable interest entities, which includes special purpose entities and other structured finance entities. CONTRACTUAL OBLIGATIONS The following table summarizes our contractual cash obligations as of December 31, 2005: Payments Due By Period - ------------------------------------------------------------------------------------------------------------------------ 2006 2007 2008 2009 2010 Thereafter Total - ------------------------------------------------------------------------------------------------------------------------ Long-term debt (a) $24,645 $ 30,959 $ 23,651 $ 6,672 $ 53,884 $ 763,272 $903,083 Interest on fixed-rate, long-term debt (b) 51,661 49,419 47,558 46,922 44,287 568,828 808,675 Operating leases (c) 3,482 3,033 2,559 1,218 969 15,264 26,525 Unconditional purchase obligations (d) 12,184 11,763 11,358 11,009 11,778 75,559 133,651 Other purchase obligations (e) 13,552 - - - - - 13,552 Postretirement benefit plans' obligations (f) 9,282 - - - - - 9,282 Other obligations (g) 3,465 400 400 257 - - 4,522 --------------------------------------------------------------------------------------------- Total $118,271 $ 95,574 $ 85,526 $ 66,078 $ 110,918 $1,422,923 $1,899,290 ============================================================================================= (a) Represents sinking fund obligations and debt maturities. (b) Represents interest payable on fixed-rate, long-term debt. Amounts reported may differ from actual due to future refinancing of debt. (c) Represents operating leases that are noncancelable, before expiration, for the lease of motor vehicles, buildings, land and other equipment. (d) Represents our commitment to purchase minimum quantities of water as stipulated in agreements with other water purveyors. We use purchased water to supplement our water supply, particularly during periods of peak customer demand. (e) Represents an approximation of the open purchase orders as of the period end for goods and services purchased in the ordinary course of business. (f) Represents contributions expected to be made to postretirement benefit plans. The amount of required contributions in 2007 and thereafter is not determinable. (g) Represents capital expenditures estimated to be required under legal and binding contractual obligations. In addition to these obligations, we pay refunds on Customers' Advances for Construction over a specific period of time based on operating revenues related to developer-installed water mains or as new customers are connected to and take service from such mains. After all refunds are paid, any remaining balance is transferred to Contributions in Aid of Construction. The refund amounts are not included in the above table because the refund amounts and timing are dependent upon several variables, including new customer connections, customer consumption levels and future rate increases, which cannot be accurately estimated. Portions of these refund amounts are payable annually through 2020 and amounts not paid by the contract expiration dates become non-refundable. We will fund these contractual obligations with cash flows from operations and liquidity sources held by or available to us. 14
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) MARKET RISK We are subject to market risks in the normal course of business, including changes in interest rates and equity prices. The exposure to changes in interest rates is a result of financings through the issuance of fixed-rate, long-term debt. Such exposure is typically related to financings between utility rate increases, because generally our rate increases provide a revenue level to allow recovery of our current cost of capital. Interest rate risk is managed through the use of a combination of long-term debt, which is at fixed interest rates and short-term debt, which is at floating interest rates. As of December 31, 2005, the debt maturities by period and the weighted average interest rate for fixed-rate, long-term debt are as follows: Fair 2006 2007 2008 2009 2010 Thereafter Total Value - ----------------------------------------------------------------------------------------------------------------------- Long-term debt (fixed rate) $24,645 $30,959 $23,651 $6,672 $53,884 $763,272 $903,083 $ 950,479 Weighted average interest rate 5.74% 5.64% 5.63% 5.72% 5.44% 5.35% 5.74% From time to time, we make investments in marketable equity securities. As a result, we are exposed to the risk of changes in equity prices for the "available for sale" marketable equity securities. As of December 31, 2005, we owned no marketable equity securities as we sold the balance of our securities during 2004. CAPITALIZATION The following table summarizes our capitalization during the past five years: December 31, 2005 2004 2003 2002 2001 - ------------------------------------------------------------------------------------------------------ Long-term debt* 52.7% 52.8% 52.8% 55.6% 52.9% Preferred stock 0.0% 0.0% 0.0% 0.0% 0.1% Common stockholders' equity 47.3% 47.2% 47.2% 44.4% 47.0% - ------------------------------------------------------------------------------------------------------ 100.0% 100.0% 100.0% 100.0% 100.0% ====================================================================================================== *Includes current portion. The changes in the capitalization ratios primarily resulted from the issuance of common stock over the past five years, and the issuance of debt to finance our acquisitions and capital program and the previously mentioned repurchase of common stock from Veolia Environnement in 2002. It is our goal to maintain an equity ratio adequate to support the current Standard and Poors corporate credit rating of "A+" and its senior secured debt rating of "AA-" for Aqua Pennsylvania, our largest operating subsidiary. DIVIDENDS ON COMMON STOCK We have paid common dividends consecutively for 61 years. Effective December 1, 2005, our Board of Directors authorized an increase of 9.6% in the dividend rate over the amount we paid in the previous quarter. As a result of this authorization, beginning with the dividend payment in December 2005, the annual dividend rate increased to $0.4276 per share. We presently intend to pay quarterly cash dividends in the future, on March 1, June 1, September 1 and December 1, subject to our earnings and financial condition, regulatory requirements and such other factors as our Board of Directors may deem relevant. During the past five years, our common dividends paid have averaged 56.3% of net income. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our financial condition and results of operations are impacted by the methods, assumptions, and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to our financial condition or results of operations, and require estimates or other judgments of matters of uncertainty. Changes in the estimates or other judgments included within these accounting policies could result in a significant change to the financial statements. We believe our most critical accounting policies 15
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) include revenue recognition, the use of regulatory assets and liabilities as permitted by Statement of Financial Accounting Standards ("SFAS") No. 71, "Accounting for the Effects of Certain Types of Regulation," the review for impairment of our long-lived assets which consist primarily of Utility Plant in Service and regulatory assets, our accounting for pensions and other postretirement benefits and our accounting for income taxes. We have discussed the selection and development of our critical accounting policies and estimates with the Audit Committee of the Board of Directors. REVENUE RECOGNITION -Our 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. The estimated usage is based on our judgment and assumptions; our actual results could differ from these estimates which would result in operating revenues being adjusted in the period that the revision to our estimates are determined. In some operating divisions, we commence the billing of our utility customers, under new rates, upon authorization from the respective regulatory commission and before the final commission rate order is issued. The revenue recognized reflects an estimate based on our judgment of the final outcome of the ruling. We monitor the facts and circumstances regularly, and revise the estimate as required. The revenue billed and collected prior to the final ruling is subject to refund based on the final ruling. Please refer to the section named "Operating Revenues" for a discussion of revenue currently being recognized under rate filings that are not final. REGULATORY ASSETS AND LIABILITIES-SFAS No. 71 stipulates generally accepted accounting principles for companies whose rates are established by or are subject to approval by an independent third-party regulator. In accordance with SFAS No. 71, we defer costs and credits on the balance sheet as regulatory assets and liabilities when it is probable that these costs and credits will be recognized in the rate-making process in a period different from when the costs and credits were incurred. These deferred amounts, both assets and liabilities, are then recognized in the income statement in the same period that they are reflected in our rates charged for water and wastewater service. In the event that our assessment as to the probability of the inclusion in the rate-making process is incorrect, the associated regulatory asset or liability would be adjusted to reflect the change in our assessment or change in regulatory approval. IMPAIRMENT OF LONG-LIVED ASSETS -In accordance with the requirements of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", we review for impairment of our long-lived assets, including Utility Plant in Service. We also review regulatory assets for the continued application of SFAS No. 71. Our review determines whether there have been changes in circumstances or events that have occurred that require adjustments to the carrying value of these assets. In accordance with SFAS No. 71, adjustments to the carrying value of these assets would be made in instances where the inclusion in the rate-making process is unlikely. ACCOUNTING FOR POSTRETIREMENT BENEFITS-We maintain a qualified defined benefit pension plan and plans that provide for certain postretirement benefits other than pensions. Accounting for pensions and other postretirement benefits requires an extensive use of assumptions about the discount rate, expected return on plan assets, the rate of future compensation increases received by our employees, mortality, turnover and medical costs. Each assumption is reviewed annually with assistance from our actuarial consultant who provides guidance in establishing the assumptions. The assumptions are selected to represent the average expected experience over time and may differ in any one year from actual experience due to changes in capital markets and the overall economy. These differences will impact the amount of pension and other postretirement benefit expense that we recognize. During 2005, we undertook a comprehensive study of the key demographic assumptions which impact the obligations and expense for these plans. Based on the study, we updated the assumed retirement and turnover rates for the plans to better reflect the recent experience combined with our expectations of future patterns. In addition, we have updated the mortality assumptions to reflect a more recent actuarial study of mortality experience and an expectation of future mortality improvements. The net effect of the changes in these assumptions was a decrease of $1,600 in our pension and postretirement benefit obligation measured as of December 31, 2005. Our discount rate assumption was determined using a yield curve that was produced from a universe containing over 500 U.S.-issued Aa-graded corporate bonds, all of which were noncallable (or callable with make-whole provisions), and excluding the 10% of the bonds with the highest yields and the 10% with the lowest yields. The discount rate was then developed as the single rate that would produce the same present value as if we used spot rates, for various time periods, to discount the projected pension benefit payments. Our pension expense and liability (benefit obligations) increases as the discount rate is reduced. A 25 basis-point reduction in this assumption would have increased 2005 pension expense by $660 and the pension liabilities by $7,000. The present values of Aqua America's future pension and other postretirement obligations were determined using discount rates of 5.65% at December 31, 2005 and 5.75% at December 31, 2004. Our expense under these plans is determined using the discount rate as of the beginning of the year, which was 5.75% for 2005, and will be 5.65% for 2006. 16
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) Our expected return on assets is determined by evaluating the asset class return expectations with our advisors as well as actual, long-term, historical results of our asset returns. Our pension expense increases as the expected return on assets decreases. A 25 basis-point reduction in this assumption would have increased 2005 pension expense by $280. For 2005, we used an 8.5% expected return on assets assumption, and will lower this assumption to 8.0% for the calculation of pension expense for 2006. This change was made to reflect a change in our expectations of long-term market returns given the recent decrease in bond yields. The expected return on assets is based on a targeted allocation of 65% equities and 35% fixed income. We believe that our actual long-term asset allocation on average will approximate the targeted allocation. Our targeted allocation is driven by the investment strategy to earn a reasonable rate of return while maintaining risk at acceptable levels through the diversification of investments across and with various asset categories. As of December 31, 2005, we have an additional minimum liability of $10,909 associated with our defined benefit pension plans. The additional minimum liability is a result of the accumulated benefit obligation exceeding the fair value of plan assets. The portion of the additional minimum liability related to our employees in one of our rate jurisdictions results in the establishment of a regulatory asset of $6,167, as we expect recovery of the future, increased pension expense through customer rates. Since the balance of the additional minimum liability of $4,742 may not be recovered through rates, the accounting requirements for recording a regulatory asset are not met and as a result this amount is recorded as accumulated other comprehensive loss through aggregate charges to accumulated other comprehensive income in 2004 and 2005, net of income tax benefits of $1,660. The change in the additional minimum liability from December 31, 2004 of $6,820 to December 31, 2005 of $10,909 resulted from the effect of a decreased discount rate, offset partially by an increase in the pension plan assets during 2005 due to positive equity market performance and pension contributions. Although additional minimum liability does not directly impact net income or cash flow, in future years, our pension expense and cash funding requirements are anticipated to increase as a result of the decline in the plans' funded status. Funding requirements for qualified defined benefit pension plans are determined by government regulations and not by accounting pronouncements. In accordance with our funding policy, during 2006 our required pension contribution is expected to be approximately $6,400. We do not expect our estimate for the 2006 funding amount to change as a result of the pending pension funding reform. Pension funding reform will impact future contributions, though we expect future changes in the amount of contributions and expense recognized will be generally included in customer rates. ACCOUNTING FOR INCOME TAXES-We estimate the amount of income tax payable or refundable for the current year and the deferred income tax liabilities and assets that results from estimating temporary differences resulting from the treatment of certain items, such as depreciation, for tax and financial statement reporting. These differences result in the recognition of a deferred tax asset or liability on our consolidated balance sheet and require us to make judgments regarding the probability of the ultimate tax impact of the various transactions we enter into. Based on these judgments we may record tax reserves or adjustments to valuation allowances on deferred tax assets to reflect the expected realization of future tax benefits. Actual income taxes could vary from these estimates and changes in these estimates can increase income tax expense in the period that these changes in estimates occur. IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS On October 22, 2004, the American Jobs Creation Act ("AJCA") was signed into law. Among other provisions, the AJCA creates a new deduction for qualified domestic production activities. Certain of our activities, such as our water treatment activity, are considered as qualifying production activities for purposes of determining the deduction for qualified production activities. In December 2004, the Financial Accounting Standards Board ("FASB") issued FSP 109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004." In accordance with FSP 109-1, we treat the deduction for qualified domestic production activities as a reduction of the income tax provision in the period realized. We adopted this statement in the first quarter of 2005 and have recorded an estimate for the effect of the statement which reduced the provision for Federal and state income taxes by approximately $740 for the year ended December 31, 2005. 17
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) In November 2004, the FASB approved Statement of Financial Accounting Standards ("SFAS") No. 151, "Inventory Costs - An Amendment of ARB No. 43, Chapter 4." SFAS No. 151 requires the exclusion of certain costs from inventories and the allocation of fixed production overheads to inventories to be based on the normal capacity of the production facilities. The standard is effective for Aqua America for costs incurred after December 31, 2005. We believe this statement will not have a material impact on our results of operations or financial position. In November 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets - - An Amendment of APB Opinion No. 29." SFAS No. 153 eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for fiscal periods beginning after June 15, 2005. We adopted this standard and it did not have a material impact on our results of operations or financial position. In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment," which revises SFAS No. 123, "Accounting for Stock-based Compensation," and supersedes APB No. 25, "Accounting for Stock Issued to Employees." As noted in the footnotes to our consolidated financial statements, we currently provide pro forma disclosure of our compensation costs associated with the fair value of stock options that have been granted. We currently account for stock-based compensation associated with stock options using the intrinsic method, and accordingly, no compensation costs have been recognized in our consolidated financial statements. SFAS 123R generally requires that we measure the cost of employee services received in exchange for stock-based awards on the grant-date fair value and this cost will be recognized over the period during which an employee provides service in exchange for the award. We adopted this standard as required on January 1, 2006. We adopted this standard using the modified prospective method in which stock option awards that are granted, modified or cancelled after the date of adoption are measured and accounted for in accordance with SFAS No. 123R. Awards that are granted prior to the effective date will continue to be accounted for in accordance with SFAS No. 123 except that the stock option expense for unvested options will be recognized in the income statement. We intend to use the Black-Scholes option-pricing model as permitted under SFAS No. 123R. The impact of adoption of SFAS No. 123R on our earnings depends on a number of variables including the level of share-based payments granted in the future, the fair value of the options granted and the associated income tax benefits that we receive. Assuming we grant a comparable number of stock options in 2006 as compared to 2005 and the fair value approximates the value of recent stock option grants reported in the notes to our consolidated financial statements, the after-tax impact of SFAS No. 123R is expected to approximate $3,000 during the year ending December 31, 2006. We believe the adoption of this standard will have no impact on our overall financial position or cash flow, but will result in the reclassification of related tax benefits from operating cash flow to financing cash flow to the extent these tax benefits exceed the associated compensation cost recognized in the income statement. In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations," which clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of settlement. We adopted this standard as required on December 15, 2005 and it did not have a material effect on our results of operations or financial position. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS No. 154 requires retrospective application to prior periods' financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle should be recognized in the period of the accounting change. SFAS No. 154 further requires that a change in depreciation, amortization or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. Aqua America intends to adopt this standard as required in 2006. 18
AQUA AMERICA, INC. AND SUBSIDIARIES MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Management of Aqua America, Inc. (the "Company") is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In assessing the effectiveness of internal control over financial reporting, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. As a result of management's assessment and based on the criteria in the framework, management has concluded that, as of December 31, 2005, the Company's internal control over financial reporting was effective. The Company's independent registered public accounting firm, PricewaterhouseCoopers LLP, has audited management's assessment of the effectiveness of the Company's internal control over financial reporting, as stated in their report which appears herein. /S/ Nicholas DeBenedictis /S/ David P. Smeltzer Nicholas DeBenedictis David P. Smeltzer Chairman, President and Chief Executive Officer Senior Vice President Finance and Chief Financial Officer March 13, 2006 19
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Aqua America, Inc.: We have completed integrated audits of Aqua America, Inc.'s 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2005 and an audit of its 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below. CONSOLIDATED FINANCIAL STATEMENTS In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income and comprehensive income, of capitalization, of common stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Aqua America, Inc. and its subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. INTERNAL CONTROL OVER FINANCIAL REPORTING Also, in our opinion, management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that the Company maintained effective internal control over financial reporting as of December 31, 2005 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management's assessment and on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. 20
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /S/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Philadelphia, PA March 13, 2006 21
AQUA AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND COMPENHENSIVE INCOME (In thousands, except per share amounts) Years ended December 31, 2005, 2004 and 2003 2005 2004 2003 ---------------------------------------- Operating revenues $ 496,779 $ 442,039 $ 367,233 Costs and expenses: Operations and maintenance 203,088 178,345 140,602 Depreciation 60,747 54,564 48,522 Amortization 4,741 4,300 2,941 Taxes other than income taxes 31,696 27,596 21,607 ---------------------------------------- 300,272 264,805 213,672 Operating income 196,507 177,234 153,561 Other expense (income): Interest expense, net 52,062 48,679 44,662 Allowance for funds used during construction (2,447) (2,304) (2,127) Gain on sale of other assets (1,177) (1,272) (5,692) ---------------------------------------- Income before income taxes 148,069 132,131 116,718 Provision for income taxes 56,913 52,124 45,923 ---------------------------------------- Net income 91,156 80,007 70,795 Dividends on preferred stock - - 10 ---------------------------------------- Net income available to common stock $ 91,156 $ 80,007 $ 70,785 ======================================== Net income $ 91,156 $ 80,007 $ 70,795 Other comprehensive income (loss), net of tax: Minimum pension liability adjustment (1,340) (1,742) - Unrealized gains on securities - 59 455 Reclassification adjustment for gains reported in net income - (230) (347) ---------------------------------------- (1,340) (1,913) 108 ---------------------------------------- Comprehensive income $ 89,816 $ 78,094 $ 70,903 ======================================== Net income per common share: Basic $ 0.72 $ 0.64 $ 0.60 ======================================== Diluted $ 0.71 $ 0.64 $ 0.59 ======================================== Average common shares outstanding during the period: Basic 127,364 124,329 117,700 ======================================== Diluted 129,206 125,710 118,993 ======================================== See accompanying notes to consolidated financial statements. 22
AQUA AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands of dollars, except per share amounts) December 31, 2005 and 2004 2005 2004 -------------------------- Assets Property, plant and equipment, at cost $ 2,900,585 $ 2,626,151 Less: accumulated depreciation 620,635 556,339 -------------------------- Net property, plant and equipment 2,279,950 2,069,812 -------------------------- Current assets: Cash and cash equivalents 11,872 14,192 Accounts receivable and unbilled revenues, net 62,690 64,538 Inventory, materials and supplies 7,798 6,903 Prepayments and other current assets 7,596 5,570 -------------------------- Total current assets 89,956 91,203 -------------------------- Regulatory assets 130,953 122,935 Deferred charges and other assets, net 37,061 34,106 Funds restricted for construction activity 68,625 17,196 Goodwill 20,180 20,122 -------------------------- $ 2,626,725 $ 2,355,374 ========================== Liabilities and Stockholders' Equity Common stockholders' equity: Common stock at $.50 par value, authorized 300,000,000 shares, issued 129,658,806 and 127,866,524 in 2005 and 2004 $ 64,829 $ 48,036 Capital in excess of par value 478,508 468,524 Retained earnings 285,132 245,115 Treasury stock, at cost, 688,625 and 686,747 shares in 2005 and 2004 (12,914) (12,702) Accumulated other comprehensive income (3,082) (1,742) Unearned compensation (550) - -------------------------- Total common stockholders' equity 811,923 747,231 -------------------------- Minority interest 1,551 1,237 Long-term debt, excluding current portion 878,438 784,461 Commitments - - Current liabilities: Current portion of long-term debt 24,645 50,195 Loans payable 138,505 74,810 Accounts payable 55,455 34,915 Accrued interest 13,052 12,029 Accrued taxes 1,111 8,975 Other accrued liabilities 30,571 33,506 -------------------------- Total current liabilities 263,339 214,430 -------------------------- Deferred credits and other liabilities: Deferred income taxes and investment tax credits 250,346 223,887 Customers' advances for construction 74,828 73,095 Regulatory liabilities 11,751 11,942 Other 31,969 21,283 -------------------------- Total deferred credits and other liabilities 368,894 330,207 -------------------------- Contributions in aid of construction 302,580 277,808 -------------------------- $ 2,626,725 $ 2,355,374 ========================== See accompanying notes to consolidated financial statements. 23
AQUA AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CAPITALIZATION (In thousands of dollars, except per share amounts) December 31, 2005 and 2004 2005 2004 -------------------------- Common stockholders' equity: Common stock, $.50 par value $ 64,829 $ 48,036 Capital in excess of par value 478,508 468,524 Retained earnings 285,132 245,115 Treasury stock, at cost (12,914) (12,702) Accumulated other comprehensive income (3,082) (1,742) Unearned compensation (550) - -------------------------- Total common stockholders' equity 811,923 747,231 -------------------------- Long-term debt: Long-term debt of subsidiaries (substantially secured by utility plant): Interest Rate Range 0.00% to 2.49% 21,574 20,051 2.50% to 2.99% 28,684 29,924 3.00% to 3.49% 17,380 17,546 3.50% to 3.99% 6,748 7,123 4.00% to 4.99% 30,695 9,435 5.00% to 5.49% 262,588 165,615 5.50% to 5.99% 79,000 89,260 6.00% to 6.49% 88,504 110,360 6.50% to 6.99% 32,000 42,000 7.00% to 7.49% 15,878 45,105 7.50% to 7.99% 25,012 25,231 8.00% to 8.49% 26,507 26,714 8.50% to 8.99% 9,000 9,000 9.00% to 9.49% 46,764 53,244 9.50% to 9.99% 40,933 42,088 10.00% to 10.50% 6,000 6,000 -------------------------- 737,267 698,696 Unsecured notes payable, 4.87%, maturing in various installments 2010 - 2023 135,000 135,000 Unsecured notes payable, 5.01%, due 2015 18,000 - Unsecured notes payable, 5.20%, due 2020 12,000 - Notes payable, 6.05%, maturing in 2006 through 2008 816 960 -------------------------- 903,083 834,656 Current portion of long-term debt 24,645 50,195 -------------------------- Long-term debt, excluding current portion 878,438 784,461 -------------------------- Total capitalization $1,690,361 $1,531,692 ========================== See accompanying notes to consolidated financial statements. 24
AQUA AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY (In thousands of dollars, except per share amounts) Accumulated Unearned Capital in Other Compensation Common excess of Retained Treasury Comprehensive on Restricted stock par value earnings stock Loss Stock Total ----------------------------------------------------------------------------- Balance at December 31, 2002 $35,034 $317,871 $180,047 $(40,421) $ 63 $ - $492,594 Net income - - 70,785 - - - 70,785 Other comprehensive income: unrealized gains on securities, net of income tax of $244 - - - - 455 - 455 Reclassification adjustment for gains reported in net income, net of income tax of $186 - - - - (347) - (347) Dividends - - (39,917) - - - (39,917) Stock split 9,244 (9,244) - - - - - Sale of stock (9,745,160 shares) 2,168 99,031 - 29,163 - - 130,362 Repurchase of stock (60,646 shares) - - - (1,353) - - (1,353) Equity Compensation Plan (26,875 shares) 8 344 - - - - 352 Exercise of stock options (579,777 shares) 181 4,283 - - - - 4,464 Employee stock plan tax benefits - 723 - - - - 723 --------------------------------------------------------------------------- Balance at December 31, 2003 46,635 413,008 210,915 (12,611) 171 - 658,118 --------------------------------------------------------------------------- Net income - - 80,007 - - - 80,007 Other comprehensive income (loss): Minimum pension liability adjustment, net of income tax of $938 - - - - (1,742) - (1,742) Unrealized gain on securities, net of income tax of $32 - - - - 59 - 59 Less: reclassification adjustment for gains reported in net income, net of income tax of $173 - - - - (230) - (230) Dividends - - (45,807) - - - (45,807) Sale of stock (3,181,203 shares) 1,170 48,971 - 991 - - 51,132 Repurchase of stock (51,808 shares) - - - (1,082) - - (1,082) Equity Compensation Plan (45,535 shares) 17 692 - - - - 709 Exercise of stock options (570,064 shares) 214 4,847 - - - - 5,061 Employee stock plan tax benefits - 1,006 - - - - 1,006 --------------------------------------------------------------------------- Balance at December 31, 2004 48,036 468,524 245,115 (12,702) (1,742) - 747,231 --------------------------------------------------------------------------- Net income - - 91,156 - - - 91,156 Other comprehensive loss: minimum pension liability adjustment, net of income tax of $722 - - - - (1,340) - (1,340) Dividends - - (51,139) - - - (51,139) Stock issued for acquisitions (24,684 shares) 12 663 - - - - 675 Stock split 16,095 (16,095) - - - - - Sale of stock (471,682 shares) 161 7,943 - 1,537 - - 9,641 Repurchase of stock (56,930 shares) - - - (1,749) - - (1,749) Equity Compensation Plan (37,751 shares) 14 708 - - - (722) - Exercise of stock options (1,327,717 shares) 511 11,264 - - - - 11,775 Employee stock plan tax benefits - 5,501 - - - - 5,501 Amortization of unearned compensation - - - - - 172 172 --------------------------------------------------------------------------- Balance at December 31, 2005 $64,829 $478,508 $285,132 $(12,914) $ (3,082) $ (550) $811,923 =========================================================================== See accompanying notes to consolidated financial statements. 25
AQUA AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED CASH FLOW STATEMENTS (In thousands of dollars) Years ended December 31, 2005, 2004 and 2003 2005 2004 2003 ------------------------------------ Cash flows from operating activities: Net income $ 91,156 $ 80,007 $ 70,795 Adjustments to reconcile net income to net cash flows from operating activities: Depreciation and amortization 65,488 58,864 51,463 Deferred income taxes 26,027 40,577 26,741 Gain on sale of water system - (2,342) - Gain on sale of other assets (1,177) (1,272) (5,692) Net decrease (increase) in receivables, inventory and prepayments 7,572 (2,766) (314) Net increase in payables, accrued interest, accrued taxes and other accrued liabilities 12,933 863 7,777 Other (2,325) (328) (7,397) ------------------------------------ Net cash flows from operating activities 199,674 173,603 143,373 ------------------------------------ Cash flows from investing activities: Property, plant and equipment additions, including allowance for funds used during construction of $2,447, $2,304 and $2,127 (237,462) (195,736) (163,320) Acquisitions of water and wastewater systems, net (11,633) (54,300) (192,331) Release of funds previously restricted for construction activity 56,137 14,015 16,339 Additions to funds restricted for construction activity (107,566) (2,772) (1,025) Net proceeds from the sale of water systems - 4,716 4,000 Net proceeds from the sale of other assets 1,300 2,098 6,496 Other 102 (517) (312) ------------------------------------ Net cash flows used in investing activities (299,122) (232,496) (330,153) ------------------------------------ Cash flows from financing activities: Customers' advances and contributions in aid of construction 14,728 14,269 8,181 Repayments of customers' advances (4,792) (4,930) (4,257) Net proceeds (repayments) of short-term debt 63,695 (30,150) (18,654) Proceeds from long-term debt 147,012 130,258 154,537 Repayments of long-term debt (83,235) (55,928) (44,204) Change in cash overdraft position (8,808) (2,190) 5,200 Redemption of preferred stock - - (172) Proceeds from issuing common stock 21,416 56,193 134,826 Repurchase of common stock (1,749) (1,082) (1,353) Dividends paid on preferred stock - - (10) Dividends paid on common stock (51,139) (45,807) (39,917) Other - 179 - ------------------------------------ Net cash flows from financing activities 97,128 60,812 194,177 ------------------------------------ Net increase (decrease) in cash and cash equivalents (2,320) 1,919 7,397 Cash and cash equivalents at beginning of year 14,192 12,273 4,876 ------------------------------------ Cash and cash equivalents at end of year $ 11,872 $ 14,192 $ 12,273 ==================================== Cash paid during the year for: Interest, net of amounts capitalized $ 48,278 $ 45,261 $ 40,572 ==================================== Income taxes $ 30,734 $ 22,322 $ 19,168 ==================================== See Summary of Significant Accounting Policies-Customers' Advances for Construction, Acquisitions and Employee Stock and and Incentive Plans footnotes for description of non-cash activities. See accompanying notes to consolidated financial statements. 26
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (In thousands of dollars, except per share amounts) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS-Aqua America, Inc. ("Aqua America" or the "Company") is the holding company for regulated utilities providing water or wastewater services in Pennsylvania, Ohio, North Carolina, Illinois, Texas, New Jersey, Florida, Indiana, Virginia, Maine, Missouri, New York and South Carolina. Our largest operating subsidiary, Aqua Pennsylvania, Inc., accounts for approximately 56% of our operating revenues for 2005 and provides water or wastewater services to customers in the suburban areas north and west of the City of Philadelphia and in 22 other counties in Pennsylvania. The Company's other subsidiaries provide similar services in 12 other states. In addition, the Company provides water and wastewater service through operating and maintenance contracts with municipal authorities and other parties close to our operating companies' service territories. The company has identified thirteen operating segments that are based on the thirteen states where we provide water or wastewater services. These operating segments are aggregated into one reportable segment since each of the Company's operating segments has the following similarities: economic characteristics, nature of services, production processes, customers, water distribution or wastewater collection methods, and the nature of the regulatory environment. REGULATION-Most of the operating companies that are regulated public utilities are subject to regulation by the public utility commissions of the states in which they operate. The respective public utility commissions have jurisdiction with respect to rates, service, accounting procedures, issuance of securities, acquisitions and other matters. Some of the operating companies that are regulated public utilities are subject to rate regulation by county or city government. Regulated public utilities follow Statement of Financial Accounting Standards ("SFAS") No. 71, "Accounting for the Effects of Certain Types of Regulation." SFAS No. 71 provides for the recognition of regulatory assets and liabilities as allowed by regulators for costs or credits that are reflected in current rates or are considered probable of being included in future rates. The regulatory assets or liabilities are then relieved as the cost or credit is reflected in rates. CONSOLIDATION-The consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated where appropriate. RECOGNITION OF REVENUES-Revenues include amounts billed to customers on a cycle basis and unbilled amounts based on estimated usage from the latest billing to the end of the accounting period. Nonregulated revenues are recognized when services are performed and are primarily associated with operating and maintenance contracts and data processing service fees. Nonregulated revenues totaled $16,484 in 2005, $13,623 in 2004 and $11,806 in 2003. PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION-Property, plant and equipment consist primarily of utility plant. The cost of additions includes contracted cost, direct labor and fringe benefits, materials, overheads and, for certain utility plant, allowance for funds used during construction. Water systems acquired are recorded at estimated original cost of utility plant when first devoted to utility service and the applicable depreciation is recorded to accumulated depreciation. The difference between the estimated original cost, less applicable accumulated depreciation, and the purchase price is recorded as an acquisition adjustment within utility plant. At December 31, 2005, utility plant includes a net credit acquisition adjustment of $64,165, which is generally being amortized from 0 to 20 years. Amortization of the acquisition adjustments totaled $3,674 in 2005, $3,961 in 2004 and $1,649 in 2003. Utility expenditures for maintenance and repairs, including major maintenance projects and minor renewals and betterments, are charged to operating expenses when incurred in accordance with the system of accounts prescribed by the public utility commissions of the states in which the company operates. The cost of new units of property and betterments are capitalized. Utility expenditures for water main cleaning and relining of pipes are deferred and recorded in net property, plant and equipment in accordance with SFAS No. 71. As of December 31, 2005, $15,788 of costs has been incurred since the last rate proceeding and the Company expects to recover these costs in future rates. The cost of software upgrades and enhancements are capitalized if they result in added functionality which enable the software to perform tasks it was previously incapable of performing. Certain information technology costs associated with major system installations, conversions and improvements, such as software training, data conversion and business process reengineering costs, are deferred as a regulatory asset if the Company expects to recover these costs in future rates. If these costs are not deferred in accordance with SFAS No. 71, then these costs are charged to operating expenses when incurred. As of December 31, 2005, $3,952 of costs have been incurred and deferred, since the last rate proceeding, as a regulatory asset, and the deferral is reported as a component of net property, plant and equipment. 27
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) When units of utility property are replaced, retired or abandoned, the recorded value thereof is credited to the asset account and such value, together with the net cost of removal, is charged to accumulated depreciation. To the extent the Company recovers cost of removal or other retirement costs through rates after the retirement costs are incurred, a regulatory asset is recorded. In some cases, the Company recovers retirement costs through rates during the life of the associated asset and before the costs are incurred. These amounts result in a regulatory liability being reported based on the amounts previously recovered through customer rates. The straight-line remaining life method is used to compute depreciation on utility plant. Generally, the straight-line method is used with respect to transportation and mechanical equipment, office equipment and laboratory equipment. In accordance with the requirements of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the long-lived assets of the Company, which consist primarily of Utility Plant in Service and regulatory assets, are reviewed for impairment when changes in circumstances or events occur. There has been no change in circumstances or events that have occurred that require adjustments to the carrying values of these assets. ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION-The allowance for funds used during construction ("AFUDC") is a non-cash credit which represents the estimated cost of funds used to finance the construction of utility plant. In general, AFUDC is applied to construction projects requiring more than one month to complete. No AFUDC is applied to projects funded by customer advances for construction or contributions in aid of construction. AFUDC includes the net cost of borrowed funds and a rate of return on other funds when used, and is recovered through water rates as the utility plant is depreciated. The amount of AFUDC related to equity funds in 2005 was $1. There was no AFUDC related to equity funds in 2004 and 2003. No interest was capitalized by our nonregulated businesses. CASH AND CASH EQUIVALENTS-The Company considers all highly liquid investments with an original maturity of three months or less, which are not restricted for construction activity, to be cash equivalents. The Company had a book overdraft for certain of its disbursement cash accounts of $2,573 and $11,381 at December 31, 2005 and 2004, respectively. A book overdraft represents transactions that have not cleared the bank accounts at the end of the period. The Company transfers cash on an as-needed basis to fund these items as they clear the bank in subsequent periods. The balance of the book overdraft is reported as accounts payable and the change in the book overdraft balance is reported as cash flows from financing activities. ACCOUNTS RECEIVABLE-Accounts receivable are recorded at the invoiced amounts. The allowance for doubtful accounts is the Company's best estimate of the amount of probable credit losses in our existing accounts receivable, and is determined based on historical write-off experience and the aging of account balances. The Company reviews the allowance for doubtful accounts quarterly. Account balances are written off against the allowance when it is probable the receivable will not be recovered. DEFERRED CHARGES AND OTHER ASSETS-Deferred charges and other assets consist of financing expenses, other costs and marketable securities. Deferred bond issuance expenses are amortized by the straight-line method over the life of the related issues. Call premiums related to the early redemption of long-term debt, along with the unamortized balance of the related issuance expense, are deferred and amortized over the life of the long-term debt used to fund the redemption. Other costs, for which the Company has received or expects to receive prospective rate recovery, are deferred and amortized over the period of rate recovery in accordance with SFAS No. 71. Marketable securities are considered "available-for-sale" and accordingly, are carried on the balance sheet at fair market value. Unrecognized gains are included in other comprehensive income. GOODWILL-Goodwill represents the excess cost over the fair value of net tangible and identifiable intangible assets acquired, and a substantial portion of the goodwill balance is associated with the acquisition of Heater Utilities, Inc. in June 2004. Goodwill is not amortized but is tested for impairment annually, or more often, if certain circumstances indicate a possible impairment may exist. In accordance with the requirements of SFAS No. 142, "Goodwill and Other Intangible Assets," the Company tested the goodwill attributable to each of our reporting units for impairment as of July 31, 2005, in conjunction with the timing of our annual strategic business plan. Based on the Company's comparison of the estimated fair value of each reporting unit to their respective carrying amounts, the impairment test concluded that none of its goodwill was impaired. 28
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) INCOME TAXES-The Company accounts for certain income and expense items in different time periods for financial reporting than for tax reporting purposes. Deferred income taxes are provided on the temporary differences between the tax basis of the assets and liabilities, and the amounts at which they are carried in the consolidated financial statements. The income tax effect of temporary differences not allowed currently in rates is recorded as deferred taxes with an offsetting regulatory asset or liability. These deferred income taxes are based on the enacted tax rates expected to be in effect when such temporary differences are projected to reverse. Investment tax credits are deferred and amortized over the estimated useful lives of the related properties. CUSTOMERS' ADVANCES FOR CONSTRUCTION AND CONTRIBUTIONS IN AID OF CONSTRUCTION- Water mains or, in some instances, cash advances to reimburse the Company for its costs to construct water mains, are contributed to the Company by customers, real estate developers and builders in order to extend water service to their properties. The value of these contributions is recorded as Customers' Advances for Construction. Non-cash property, in the form of water mains, has been received, generally from developers, as advances or contributions of $15,729, $9,273 and $9,991 in 2005, 2004 and 2003, respectively. The Company makes refunds on these advances over a specific period of time based on operating revenues related to the main or as new customers are connected to and take service from the main. After all refunds are made, any remaining balance is transferred to Contributions in Aid of Construction. Contributions in aid of construction include direct non-refundable contributions and the portion of customers' advances for construction that become non-refundable. Contributed property is generally not depreciated. Certain of the subsidiaries do depreciate contributed property and amortize contributions in aid of construction at the composite rate of the related property. INVENTORIES, MATERIALS AND SUPPLIES-Inventories are stated at cost. Cost is principally determined using the first-in, first-out method. STOCK-BASED COMPENSATION-The Company currently accounts for stock-based compensation using the intrinsic value method in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees". Accordingly, no compensation expense related to granting of stock options has been recognized in the financial statements for stock options that have been granted. Please refer to the Recent Accounting Pronouncements section of this footnote for information concerning changes to the Company's accounting for stock-based compensation, including the expected after-tax impact of adopting SFAS No. 123R, "Share-Based Payment." Pursuant to the current disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, pro forma net income available to common stock and earnings per share are presented in the following table as if compensation cost for stock options was determined as of the grant date under the fair value method: Years Ended December 31, ----------------------------------------- 2005 2004 2003 ----------------------------------------- Net income available to common stock, as reported $ 91,156 $ 80,007 $ 70,785 Add: stock-based employee compensation expense included in reported net income, net of tax 290 266 224 Less: pro forma expense related to stock options granted, net of tax effects (2,054) (1,990) (1,793) --------------------------------------- Pro forma $ 89,392 $ 78,283 $ 69,216 ======================================= Basic net income per share: As reported $ 0.72 $ 0.64 $ 0.60 Pro forma 0.70 0.63 0.59 Diluted net income per share: As reported $ 0.71 $ 0.64 $ 0.59 Pro forma 0.69 0.62 0.58 29
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) The per share weighted-average fair value at the date of grant for stock options granted during 2005, 2004 and 2003 was $4.23, $4.07 and $3.50 per option, respectively. The fair value of options at the date of grant was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions: 2005 2004 2003 ------------------------------ Expected life (years) 6.0 4.5 5.6 Interest rate 4.1% 4.0% 3.7% Volatility 23.4% 29.9% 32.4% Dividend yield 2.4% 2.2% 2.6% USE OF ESTIMATES IN PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS-The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RECLASSIFICATIONS AND REVISIONS-Certain prior year amounts have been changed to conform with current year's presentation. The changes include the presentation of regulatory assets and cash overdrafts. Regulatory assets were previously reported on a net basis. This presentation was changed to report regulatory assets and liabilities on a gross basis and regulatory liabilities have been reclassified to deferred credits and other liabilities. Cash overdrafts were previously reported as components of cash or loans payable. This presentation was changed to classify cash overdrafts as accounts payable. Accordingly, applicable historic balance sheet and cash flow amounts have been revised to conform to the new presentation and a new line has been added in the cash flow from financing activities section titled "change in cash overdraft position". This revision had no impact on the Company's net income, cash flows from operating activities or cash flows used in investing activities. The revision impacted the Company's net cash flows from financing activities from that which was previously reported, by a $440 decrease for the year ended December 31, 2004, and an increase of $2,555 for the year ended December 31, 2003. RECENT ACCOUNTING PRONOUNCEMENTS-On October 22, 2004, the American Jobs Creation Act ("AJCA") was signed into law. Among other provisions, the AJCA creates a new deduction for qualified domestic production activities. Certain activities of the Company, such as our water treatment activity, are considered as qualifying production activities for purposes of determining the deduction for qualified production activities. In December 2004, the Financial Accounting Standards Board ("FASB") issued FSP 109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004." In accordance with FSP 109-1, the Company will treat the deduction for qualified domestic production activities as a reduction of the income tax provision in the period realized. The Company adopted this statement in the first quarter of 2005 and has recorded an estimate for the effect of the statement which reduced the provision for Federal and state income taxes by approximately $740 for the year ended December 31, 2005. In November 2004, the FASB approved Statement of Financial Accounting Standards ("SFAS") No. 151, "Inventory Costs - An Amendment of ARB No. 43, Chapter 4." SFAS No. 151 requires the exclusion of certain costs from inventories and the allocation of fixed production overheads to inventories to be based on the normal capacity of the production facilities. The standard is effective for the Company for costs incurred after December 31, 2005. The Company believes this statement will not have a material impact on its results of operations or financial position. In November 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets - - An Amendment of APB Opinion No. 29." SFAS No. 153 eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for fiscal periods beginning after June 15, 2005. The Company adopted this statement and it did not have a material impact on the Company's results of operations or financial position. 30
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment," which revises SFAS No. 123, "Accounting for Stock-based Compensation," and supersedes APB No. 25, "Accounting for Stock Issued to Employees." As noted in the section captioned "Stock-based Compensation" in the Summary of Significant Accounting Policies footnote, the Company currently provides pro forma disclosure of its compensation costs associated with the fair value of stock options that have been granted. The Company currently accounts for stock-based compensation associated with stock options using the intrinsic method, and accordingly, no compensation costs have been recognized in its consolidated financial statements. SFAS 123R generally requires that we measure the cost of employee services received in exchange for stock-based awards on the grant-date fair value and this cost will be recognized over the period during which an employee provides service in exchange for the award. The Company adopted this standard as required on January 1, 2006. The Company adopted this standard using the modified prospective method in which stock option awards that are granted, modified or cancelled after the date of adoption are measured and accounted for in accordance with SFAS No. 123R. Awards that are granted prior to the effective date will continue to be accounted for in accordance with SFAS No. 123 except that the stock option expense for unvested options will be recognized in the income statement. The Company intends to use the Black-Scholes option-pricing model as permitted under SFAS No. 123R. The impact of adoption of SFAS No. 123R on the Company's earnings depends on a number of variables including the level of share-based payments granted in the future, the fair value of the options granted and the associated income tax benefits that the Company receives. Assuming the Company grants a comparable number of stock options in 2006 as compared to 2005 and the fair value approximates the value of recent stock option grants reported in the notes to our consolidated financial statements, the after-tax impact of SFAS No. 123R is expected to approximate $3,000 during the year ending December 31, 2006. The Company believes that the adoption of this standard will have no impact on our overall financial position or cash flow, but will result in the reclassification of related tax benefits from operating cash flow to financing cash flow to the extent these tax benefits exceed the associated compensation cost recognized in the income statement. In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations," which clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of settlement. The Company adopted this standard as required on December 15, 2005 and it did not have a material effect on its results of operations or financial position. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS No. 154 requires retrospective application to prior periods' financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle should be recognized in the period of the accounting change. SFAS No. 154 further requires that a change in depreciation, amortization or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. The Company intends to adopt this standard as required in 2006. 31
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) ACQUISITIONS HEATER-Pursuant to our strategy to grow through acquisitions, on June 1, 2004 the Company acquired the capital stock of Heater Utilities, Inc. for $48,000 in cash and the assumption of long-term debt of $19,219 and short-term debt of $8,500. The acquired operation provides water and wastewater service to over 50,000 water and wastewater customers primarily in the areas of suburban Raleigh, Charlotte, Gastonia and Fayetteville, North Carolina. For the fiscal year ended December 31, 2003, Heater had operating revenues of $19,489. The acquisition was accounted for as a purchase and accordingly, the purchase price is allocated to the net tangible and intangible assets based upon their estimated fair values at the date of the acquisition. The Company obtained a third-party valuation of these assets and liabilities, and it resulted in the recording of a purchase accounting fair value adjustment of $3,141 to increase the carrying-value of long-term debt assumed. The purchase price allocation is as follows: June 1, 2004 -------- Property, plant and equipment, net $ 96,779 Current assets 4,133 Other long-term assets 6,005 Goodwill 18,842 -------- Total assets acquired 125,759 -------- Current liabilities 3,063 Loans payable 8,500 Long-term debt 22,360 Other long-term liabilities 43,836 -------- Total liabilities assumed 77,759 -------- Net assets acquired $ 48,000 ======== The Company has recorded goodwill of $18,842, and a substantial portion of the goodwill is expected to be deductible for tax purposes. The purchase price was arrived at through arms-length negotiations with the seller and is consistent with the multiples paid in other comparable transactions. Aqua America considered important regulatory, strategic and valuation considerations in arriving at the final purchase price. During 2004, through the North Carolina Utilities Commission approval process, a mechanism has been developed through which the Company could recover up to two-thirds of the goodwill through customer rates in the future upon achieving certain objectives. The Company intends to pursue these objectives to facilitate recognition of this premium in customer rates. However, there can be no assurance that the Company will be able to achieve these objectives and recover such amount of goodwill, if any. FLORIDA WATER-On June 30, 2004, the Company acquired certain utility assets of Florida Water Services Corporation, comprised of 63 water and wastewater systems located in central Florida for $14,747 in cash. In accordance with Florida Public Service Commission procedures, the acquisition was approved by the Commission and rate base was determined on December 20, 2005. Under the terms of the purchase agreement, the Commission's rate base determination will result in a reduction of the final purchase price that could be as much as approximately $2,000, which is not expected to result in the recognition of goodwill. AQUASOURCE-Pursuant to our strategy to grow through acquisitions, on July 31, 2003, the Company completed its acquisition of four operating water and wastewater subsidiaries of AquaSource, Inc. (a subsidiary of DQE, Inc.), including selected, integrated operating and maintenance contracts and related assets (individually and collectively the acquisition is referred to as "AquaSource") for $190,717 in cash, as adjusted pursuant to the purchase agreement based on working capital at closing. On August 27, 2004, we were awarded and received $12,289 plus interest in an arbitration related to the calculation of the final purchase price under the terms of the purchase agreement, which resulted in a final purchase price of $178,428. In the consolidated statement of cash flow for 2004, the $12,289 award has been reported as proceeds on the line titled acquisitions of water and wastewater systems, net. 32
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) The results of AquaSource have been included in the Company's consolidated financial statements beginning August 1, 2003. The acquired operations of AquaSource serve over 130,000 water and wastewater customer accounts in 11 states (including the Connecticut and Kentucky operations which were subsequently sold to other parties). Please refer to the Dispositions footnote for a discussion of the AquaSource operations located in Connecticut and Kentucky. The AquaSource acquisition was initially funded by a portion of the proceeds from the July 2003 issuance of $135,000 of unsecured notes due 2023, with an interest rate of 4.87%, and the issuance of a $90,000 unsecured note by Aqua America. In August 2003, the $90,000 unsecured note was repaid with the proceeds from the issuance of 6,666,667 shares of common stock through a shelf registration. Under the purchase method of accounting, the purchase price is allocated to AquaSource's net tangible and intangible assets based upon their estimated fair values at the date of the acquisition. The purchase price allocation, which reflects the effects of the August 2004 purchase price arbitration proceeding, is as follows: July 31, 2003 -------- Property, plant and equipment, net $197,719 Current assets 9,687 Other long-term assets 14,204 Assets held for sale, net 4,096 -------- Total assets acquired 225,706 -------- Current liabilities 8,214 Long-term debt 7,170 Other long-term liabilities 31,894 -------- Total liabilities assumed 47,278 -------- Net assets acquired $178,428 ======== The following supplemental pro forma information is presented to illustrate the effects of the AquaSource acquisition, which was completed on July 31, 2003, on the historical operating results for the year ended December 31, 2003 as if the acquisition had occurred at the beginning of the period (unaudited): Operating revenues $407,628 Net income $ 74,436 Net income per common share: Basic $ 0.61 Diluted $ 0.60 The supplemental information is not necessarily representative of the actual results that may have occurred for this period or of the results that may occur in the future. This information does not reflect the effects of recent rate increases or cost savings that may result from the acquisition, such as the effects of a reduction in administrative costs. This information is based upon the historical operating results of AquaSource for periods prior to the acquisition date of July 31, 2003 as provided to the Company by AquaSource, Inc. and DQE, Inc. management. OTHER ACQUISITIONS- During 2005, the Company completed 30 acquisitions or other growth ventures in various states. The total purchase price of $12,308 for the systems acquired in 2005 consisted of $11,633 in cash and the issuance of 24,684 shares of the Company's common stock. The operating revenues included in the consolidated financial statements of the Company during the period owned by the Company were $2,145. During 2004, in addition to the Heater and Florida Water acquisitions, the Company completed 27 acquisitions or other growth ventures in the various states in which the Company operates for an aggregate purchase price of $3,842 in cash. The operating revenues included in the consolidated financial statements of the Company during the period owned by the Company were $1,281 in 2005 and $617 in 2004. 33
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) During 2003, in addition to the AquaSource acquisition, the Company completed 17 acquisitions or other growth ventures in the various states in which the Company operates for an aggregate purchase price of $1,614 in cash. Operating revenues included in the consolidated financial statements of the Company related to these systems were $976 in 2005, $860 in 2004 and $312 in 2003. DISPOSITIONS In December 2004, as a result of the settlement of a condemnation action, the Company's Ohio operating subsidiary sold its water utility assets within the municipal boundaries of the City of Geneva in Ashtabula County, Ohio for net proceeds of approximately $4,716, which was in excess of the book value for these assets. The proceeds were used to pay-down short-term debt and the sale resulted in the recognition in the fourth quarter of 2004 of a gain on the sale of these assets, net of expenses, of $2,342. The gain is reported in the 2004 consolidated statement of income as a reduction to operations and maintenance expense. We continue to operate this water system for the City of Geneva under an operating contract that began upon the closing of the sale for a period through December 2006. The operating contract provides for an annual base operating fee of $135 and allows for additional fees to be earned commensurate with the services provided. These water utility assets represent less than 1% of Aqua America's total assets, and the total number of customers included in the water system sold represents less than 1% of our total customer base. In July 2004, the Company sold its only operations in Kentucky. The sale price approximates our investment in this operation. The operation represented approximately 0.2% of the operations acquired from AquaSource, Inc. In October 2003, the Company sold its only operation in Connecticut. The sale price of $4,000 approximates our investment in this operation. The operation represented approximately 2% of the operations acquired from AquaSource, Inc. The City of Fort Wayne, Indiana has authorized the acquisition, by eminent domain or otherwise, of a portion of the utility assets of one of the operating subsidiaries that the Company acquired in connection with the AquaSource acquisition in 2003. The Company has challenged whether the City is following the correct legal procedures in connection with the City's attempted condemnation and the Company has challenged the City's valuation of this portion of its system. The portion of the system under consideration represents approximately 1% of the Company's total customer base. While the Company continues to discuss this matter with officials from the City of Fort Wayne, the Company continues to protect its interests in this proceeding. The Company believes that it will be entitled to fair market value for its assets if they are condemned, and it is believed that the fair market value will be in excess of the book value for such assets. PROPERTY, PLANT AND EQUIPMENT December 31, -------------------------------- Approximate range 2005 2004 of remaining lives -------------------------------- ------------------------ Utility plant and equipment: Mains and accessories $1,187,597 $1,087,712 10 to 85 years Services, hydrants, treatment plants and reservoirs 660,279 607,331 5 to 85 years Operations structures and water tanks 222,107 218,888 15 to 77 years Miscellaneous pumping and purification equipment 376,599 342,985 10 to 50 years Meters, data processing, transportation and operating equipment 341,550 298,015 5 to 50 years Land and other non-depreciable assets 73,346 67,260 - ----------------------------- Utility Plant and equipment 2,861,478 2,622,191 Utility construction work in progress 98,898 63,754 - Net utility plant acquisition adjustment (64,165) (63,347) 0 to 20 years Non-utility plant and equipment 4,374 3,553 2 to 40 years ----------------------------- Total property, plant and equipment $2,900,585 $2,626,151 ============================= 34
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) ACCOUNTS RECEIVABLE December 31, ------------------------- 2005 2004 ------------------------- Billed utility revenue $ 42,541 $ 39,783 Unbilled utility revenue 21,419 27,927 Other 3,136 1,677 ------------------------- 67,096 69,387 Less allowance for doubtful accounts 4,406 4,849 ------------------------- Net accounts receivable $ 62,690 $ 64,538 ========================= The Company's customers are located principally in the following states: 48% in Pennsylvania, 10% in Ohio, 9% in North Carolina, 8% in Illinois, 6% in Texas, 6% in New Jersey, 4% in Florida, and 4% in Indiana. No single customer accounted for more than one percent of the Company's operating revenues during the years ended December 31, 2005, 2004 or 2003. The following table summarizes the changes in the Company's allowance for doubtful accounts: 2005 2004 2003 -------------------------------------- Balance at January 1, $ 4,849 $ 5,851 $ 3,580 Amounts charged to expense 3,116 3,695 2,643 Accounts written off (4,113) (5,460) (2,715) Recoveries of accounts written off 554 701 253 Allowance acquired through acquisitions - 62 2,090 -------------------------------------- Balance at December 31, $ 4,406 $ 4,849 $ 5,851 ====================================== 35
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) REGULATORY ASSETS AND LIABILITIES The regulatory assets represent costs that are expected to be fully recovered from customers in future rates while regulatory liabilities represent amounts that are expected to be refunded to customers in future rates or amounts recovered from customers in advance of incurring the costs. Except for income taxes and the competitive transition charge payment, regulatory assets and regulatory liabilities are excluded from the Company's rate base and do not earn a return. The components of regulatory assets and regulatory liabilities are as follows: December 31, December 31, --------------------------- ---------------------------- 2005 2004 --------------------------- ---------------------------- Regulatory Regulatory Regulatory Regulatory Assets Liabilities Assets Liabilities ------------- ----------- ------------- ------------ Income taxes $69,531 $2,203 $68,990 $3,283 Utility plant retirement costs 17,421 8,368 14,729 8,184 Postretirement benefits 10,871 - 11,403 - Texas rate filing expense deferral 9,486 - 3,365 - CTC payment 5,733 - 6,879 - Water tank painting 4,292 267 4,593 130 Fair value of long-term debt assumed in acquisition 2,804 - 3,015 - Merger costs 1,641 - 2,170 - Rate case filing expenses & other 9,174 913 7,791 345 -------------------------- ---------------------------- $ 130,953 $11,751 $122,935 $11,942 ========================== ============================ Items giving rise to deferred state income taxes, as well as a portion of deferred Federal income taxes related to certain differences between tax and book depreciation expense, are recognized in the rate setting process on a cash or flow-through basis and will be recovered as they reverse. The regulatory asset for utility plant retirement costs, including cost of removal, represents costs already incurred that are expected to be recovered in future rates over a five year recovery period. The regulatory liability for utility plant retirement costs represents amounts recovered through rates during the life of the associated asset and before the costs are incurred. Postretirement benefits include pension and other postretirement benefits. The pension costs include deferred net pension expense in excess of amounts funded which the Company believes will be recoverable in future years as pension funding is required, and in addition includes an additional minimum liability for pensions as a result of a decline in the discount rate assumed for pension obligations and a change in the fair market value of plan assets. The additional minimum liability equals the excess of the accumulated benefit obligation over the fair value of plan assets. The regulatory asset related to postretirement benefits other than pensions represents costs that were deferred between the time that the accrual method of accounting for these benefits was adopted in 1993 and the recognition of the accrual method in the Company's rates as prescribed in subsequent rate filings. Amortization of the amount deferred for postretirement benefits other than pensions began in 1994 and is currently being recovered in rates. The regulatory asset for the Texas rate filing of 2004 results from a multi-year plan to increase annual revenues in phases, and to defer and amortize a portion of the Company's depreciation, operating and other tax expense over a similar multi-year period. The regulatory asset associated with the Competitive Transition Charge ("CTC") payment represents the full payoff in 2001, net of amortization, of the allocable share of a CTC as negotiated by Aqua Pennsylvania, Inc. from an electric distribution company. The Pennsylvania Electricity Generation Customer Choice and Competition Act permitted electric distribution utilities to recover their stranded costs from its customers in the form of a CTC. Rate recovery of the $11,465 CTC payment began in 2000 and is expected to conclude in 2010. Expenses associated with water tank painting are deferred and amortized over a period of time as approved in the regulatory process. 36
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) As a requirement of purchase accounting, the Company recorded a fair value adjustment for fixed-rate, long-term debt assumed in the Heater Utilities, Inc. acquisition in 2004. The regulatory asset results from the rate setting process continuing to recognize the historical interest cost of the assumed debt. The regulatory asset related to the recovery of merger costs represents the portion of the Consumers Water Company merger costs that will be recovered in rates as a result of a rate settlement in 2000 and is being amortized over the recovery period. The regulatory asset related to rate case filing expenses represents the costs associated with filing for rate increases that are deferred and amortized over periods that generally range from one to five years. The regulatory asset related to the costs incurred for information technology software projects and water main cleaning and relining projects are described in the Summary of Significant Accounting Policies - Property Plant and Equipment and Depreciation. INCOME TAXES The provision for income taxes consists of: Years Ended December 31, --------------------------------------- 2005 2004 2003 --------------------------------------- Current: Federal $ 24,417 $ 2,042 $ 11,933 State 6,586 7,553 7,249 --------------------------------------- 31,003 9,595 19,182 --------------------------------------- Deferred: Federal 22,294 41,414 25,521 State 3,616 1,115 1,220 --------------------------------------- 25,910 42,529 26,741 --------------------------------------- Total tax expense $ 56,913 $ 52,124 $ 45,923 ======================================= The statutory Federal tax rate is 35% and for states with a corporate net income tax, the state corporate net income tax rates range from 5.00% to 9.99% for all years presented. The Company's Federal income tax returns for all years through 2001 have been closed, and 2002 was closed as a result of the conclusion of a tax audit. The reasons for the differences between amounts computed by applying the statutory Federal income tax rate to income before income tax expense are as follows: Years Ended December 31, -------------------------------------- 2005 2004 2003 -------------------------------------- Computed Federal tax expense at statutory rate $ 51,824 $ 46,245 $ 40,852 Increase in tax expense for depreciation expense to be recovered in future rates 806 1,376 1,125 Domestic Production Credit (656) - - Deduction for Aqua America common dividends paid under employee benefit plan (321) (245) (241) Amortization of deferred investment tax credits (359) (285) (285) Prior year rate reductions (437) (538) (431) State income taxes, net of federal tax benefit 6,631 5,634 5,505 Other, net (575) (63) (602) -------------------------------------- Actual income tax expense $ 56,913 $ 52,124 $ 45,923 ====================================== 37
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) The tax effects of temporary differences between book and tax accounting that give rise to the deferred tax assets and deferred tax liabilities are as follows: December 31, -------------------------- 2005 2004 -------------------------- Deferred tax assets: Customers' advances for construction $ 17,549 $ 17,057 Costs expensed for book not deducted for tax, principally accrued expenses 1,803 1,989 Utility plant acquisition adjustment basis differences 29,429 30,920 Minimum pension liability adjustment 1,660 938 -------------------------- Total gross deferred tax assets 50,441 50,904 -------------------------- Deferred tax liabilities: Utility plant, principally due to depreciation and differences in the basis of fixed assets due to variation in tax and book accounting 267,835 243,953 Deferred taxes associated with the gross-up of revenues necessary to recover, in rates, the effect of temporary differences 25,796 23,670 Deferred investment tax credit 6,066 6,328 Unrealized gain on marketable securities - - Other 1,090 840 -------------------------- Total gross deferred tax liabilities 300,787 274,791 -------------------------- Net deferred tax liability $250,346 $223,887 ========================== On October 22, 2004, the American Jobs Creation Act ("AJCA") was signed into law. Among other provisions, the AJCA creates a new deduction for qualified domestic production activities. Certain activities of the Company, such as our water treatment activity, are considered as qualifying production activities for purposes of determining the deduction for qualified production activities. In December 2004, the FASB issued FSP 109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004." In accordance with FSP 109-1, the Company will treat the deduction for qualified domestic production activities as a reduction of the income tax provision in the period realized. The Company adopted this statement in 2005 and has recorded an estimate for the effect of the statement which reduced the provision for Federal and state income taxes by approximately $740 for the year ended December 31, 2005. COMMITMENTS The Company maintains agreements with other water purveyors for the purchase of water to supplement its water supply, particularly during periods of peak demand. The agreements stipulate purchases of minimum quantities of water to the year 2026. The estimated annual commitments related to such purchases through 2010 are expected to approximate $11,618 and $75,559 thereafter. The Company purchased approximately $10,603, $8,724 and $8,014 of water under these agreements during the years ended December 31, 2005, 2004 and 2003, respectively. The Company leases motor vehicles, buildings and other equipment under operating leases that are noncancelable. The future annual minimum lease payments due are: $2,934 in 2006, $2,488 in 2007, $2,012 in 2008, $670 in 2009, $430 in 2010 and $256 thereafter. The Company leases parcels of land on which treatment plants and other facilities are situated and adjacent parcels that are used for watershed protection. The operating leases are noncancelable, expire between 2012 and 2052 and contain certain renewal provisions. Certain leases are subject to an adjustment every five years based on changes in the Consumer Price Index. Subject to the aforesaid adjustment, during each of the next five years, approximately $545 of annual lease payments for land are due, and $15,009 thereafter. The Company leases treatment plants to other parties under lease agreements that require payments to the Company of $567 in 2006, $267 in 2007, $308 in 2008, $246 in 2009, $246 in 2010 and $3,430 thereafter. Rent expense was $3,390, $3,267 and $2,993 for the years ended December 31, 2005, 2004 and 2003, respectively. 38
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) LONG-TERM DEBT AND LOANS PAYABLE The Consolidated Statements of Capitalization provide a summary of long-term debt as of December 31, 2005 and 2004. The supplemental indentures with respect to certain issues of the First Mortgage Bonds restrict the ability of Aqua Pennsylvania, Inc. and certain other operating subsidiaries of the Company to declare dividends, in cash or property, or repurchase or otherwise acquire the stock of these companies. As of December 31, 2005, approximately $281,000 of Aqua Pennsylvania's retained earnings and $69,000 of the retained earnings of certain other subsidiaries were free of these restrictions. Certain supplemental indentures also prohibit Aqua Pennsylvania and certain other subsidiaries of the Company from making loans to, or purchasing the stock of, the Company. Sinking fund payments are required by the terms of certain issues of long-term debt. The future sinking fund payments and debt maturities of the Company's long-term debt are as follows: Interest Rate Range 2006 2007 2008 2009 2010 Thereafter ------------------------------------------------------------------------------- 0.00% to 2.49% $ 1,320 $ 1,340 $ 1,354 $ 1,378 $ 1,395 $ 14,787 2.50% to 2.99% 6,502 1,489 1,534 1,583 1,657 15,919 3.00% to 3.49% 265 12,270 278 288 298 3,981 3.50% to 3.99% 675 685 695 706 717 3,270 4.00% to 4.99% 50 50 50 55 27,055 138,435 5.00% to 5.49% - - - - 292,588 5.50% to 5.99% - - - - - 79,000 6.00% to 6.49% 144 644 10,172 - - 78,360 6.50% to 6.99% 10,000 10,000 - - - 12,000 7.00% to 7.49% 2,499 2,540 2,585 634 687 6,933 7.50% to 7.99% 194 210 227 245 264 23,872 8.00% to 8.49% 139 152 167 184 202 25,663 8.50% to 8.99% - - - - - 9,000 9.00% to 9.49% 663 584 594 604 20,615 23,704 9.50% to 9.99% 2,194 995 5,995 995 994 29,760 10.00% to 10.50% - - - - - 6,000 ----------------------------------------------------------------------------------- Total $ 24,645 $ 30,959 $ 23,651 $ 6,672 $53,884 $ 763,272 =================================================================================== In February 2005, the Company issued $30,000 of unsecured notes of which $18,000 are due in 2015 with an interest rate of 5.01% and $12,000 are due in 2020 with an interest rate of 5.20%. The proceeds of this financing were used to refinance existing short-term debt. In May 2005, Aqua Pennsylvania issued $72,000 of tax-exempt bonds secured by a supplement to its first mortgage indenture at the following terms: $22,000 at 4.87% due 2036, $25,000 at 4.88% due 2037 and $25,000 at 4.89% due 2038. Of the $72,000 in proceeds, $22,000 was used to retire previously issued tax-exempt bonds in August 2005 and the balance of proceeds are restricted to funding the costs of certain capital projects during the period 2005 through 2007. In December 2005, Aqua Pennsylvania issued $25,000 of tax-exempt bonds at 4.82% due 2035, which were secured by a supplement to its first mortgage indenture. The proceeds are restricted to funding certain capital projects during the period 2006 through 2008. At various times during 2005, Aqua Pennsylvania and other operating subsidiaries issued other notes payable, first mortgage bonds and tax-exempt bonds aggregating $24,677 at a weighted-average interest rate of 4.10% due at various times ranging from 2019 to 2035. The proceeds from these issuances were used to reduce a portion of the balance of short-term debt at each of the respective operating subsidiaries and to redeem $10,260 of first mortgage bonds of an operating subsidiary with an interest rate of 5.60%. As of December 31, 2005, the Trustees for 12 issues held $68,625 pending construction of the projects to be financed with the issues and are reported in the consolidated balance sheet as funds restricted for construction activity. 39
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) In May 2004, Aqua Pennsylvania issued $87,000 of First Mortgage Bonds secured by a supplement to its first mortgage indenture with a weighted-average interest rate of approximately 5.1% and a weighted-average maturity of 13.7 years. The proceeds from this issuance were used to refinance short-term debt and to fund long-term debt maturities. In May 2004, an unsecured note of $70,000 was issued by the Company. Interest under this note is based, at the borrower's option, on either a defined base rate or an adjusted London Interbank Offered Rate corresponding to the interest period selected. The proceeds of this financing were used to fund acquisitions and to refinance existing debt. In November 2004, $34,000 of the $70,000 unsecured note was repaid with the proceeds from an equity offering. The remaining balance of the note of $36,000 was repaid in May 2005. In connection with the acquisition of Heater Utilities, Inc. in 2004, the Company assumed $22,360 of long-term debt at interest rates ranging from 7.05% to 8.24% due 2012 to 2025, which includes the purchase accounting fair value adjustment of $3,141, increasing the carrying-value of long-term debt. In November 2004, Aqua Pennsylvania issued $14,000 tax-exempt bonds due 2039 at a rate of 5.05% and secured by a supplement to its first mortgage indenture. The proceeds from the bonds issued were used to retire previously issued tax-exempt bonds. At various times during 2004, Aqua Pennsylvania and other operating subsidiaries issued other notes payable and first mortgage bonds aggregating $31,239 at a weighted-average interest rate of 3.76% due at various times ranging from 2006 to 2037. The proceeds from these issuances were used to reduce a portion of the balance of the short-term debt at each of the respective operating subsidiaries and to redeem $6,000 of first mortgage bonds with a weighted-average interest rate of 9.19%. The weighted average cost of long-term debt at December 31, 2005 and 2004 was 5.74% and 6.00%, respectively. Aqua Pennsylvania has a $70,000 364-day revolving credit facility with four banks and the Company has a $20,000 364-day bank revolving credit facility. Funds borrowed under these agreements are classified as loans payable and are used to provide working capital. As of December 31, 2005 and 2004, funds borrowed under the Aqua Pennsylvania revolving credit agreements were $65,000 and $29,000, respectively, and $17,000 and $0 were borrowed under the Company's revolving credit agreement, respectively. Interest under these facilities is based, at the borrower's option, on the prime rate, an adjusted federal funds rate, an adjusted London Interbank Offered Rate corresponding to the interest period selected, an adjusted Euro-Rate corresponding to the interest period selected or at rates offered by the banks. These agreements restrict short-term borrowings of Aqua Pennsylvania and the Company. A commitment fee of 1/10 of 1% is charged on the total commitment amount of Aqua Pennsylvania's revolving credit agreement. The average cost of borrowing under these facilities was 3.8% and 1.4%, and the average borrowing was $63,355 and $50,115, during 2005 and 2004, respectively. The maximum amount outstanding at the end of any one month was $85,000 in 2005 and $89,519 in 2004. At December 31, 2005 and 2004, the Company had combined short-term lines of credit of $127,000 and $108,000, respectively. Funds borrowed under these lines are classified as loans payable and are used to provide working capital. As of December 31, 2005 and 2004, funds borrowed under the short-term lines of credit were $56,505 and $9,810, respectively. The average borrowing under the lines was $35,610 and $34,711 during 2005 and 2004, respectively. The maximum amount outstanding at the end of any one month was $56,505 in 2005 and $51,288 in 2004. Interest under the lines is based at the Company's option, depending on the line, on the prime rate, an adjusted Euro-Rate, an adjusted federal funds rate or at rates offered by the banks. The average cost of borrowings under all lines during 2005 and 2004 was 3.9% and 2.3%, respectively. Interest income of $3,040, $1,762 and $395 was netted against interest expense on the consolidated statements of income for the years ended December 31, 2005, 2004 and 2003, respectively. The total interest cost was $55,102, $50,441 and $45,057 in 2005, 2004 and 2003, including amounts capitalized of $2,447, $2,304 and $2,127, respectively. 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: December 31, ------------------------- 2005 2004 ------------------------- Carrying amount $903,083 $834,656 Estimated fair value 950,479 863,247 40
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) 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 $74,828 and $73,095 at December 31, 2005 and 2004, respectively. 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 2020 and amounts not paid by the contract expiration dates become non-refundable. The fair value of these amounts would, however, be less than their carrying value due to the non-interest bearing feature. STOCKHOLDERS' EQUITY At December 31, 2005, the Company had 300,000,000 shares of common stock authorized; par value $0.50. Shares outstanding at December 31, 2005, 2004 and 2003 were 128,970,181, 127,179,777 and 123,452,053, respectively. Treasury shares held at December 31, 2005, 2004 and 2003 were 688,625, 686,747 and 681,384, respectively. At December 31, 2005, the Company had 1,770,819 shares of authorized but unissued Series Preferred Stock, $1.00 par value. In August 2005, the Company's Board of Directors declared a 4-for-3 common stock split to be effected in the form of a 33 1/3% stock distribution for all common shares outstanding, to shareholders of record on November 17, 2005. Common shares outstanding do not include shares held by the Company in treasury. The new shares were distributed on December 1, 2005. The Company's par value of $0.50 per share remained unchanged and $16,095 was transferred from Capital in Excess of Par Value to Common Stock to record the split. All common share and per common share data for all periods presented have been restated to give effect to the stock split. In December 2005, the Company filed a universal shelf registration with the Securities and Exchange Commission to allow for the potential future sale by us, from time to time, in one or more public offerings, of an indeterminant amount of our common stock, preferred stock, debt securities and other securities specified therein at indeterminant prices. No issuances have been completed to date under this shelf registration. During the last three years, the Company completed the following offerings of equity: o In November 2004, the Company issued 2,606,667 shares of common stock in a public offering for proceeds of $42,600, net of expenses. The net proceeds were used to repay a portion of our short-term debt. The indebtedness was incurred by Aqua America in connection with acquisitions. o In August 2003, the Company issued 6,666,667 shares of common stock in a public offering for proceeds of $90,100, net of expenses. The net proceeds were used to repay an unsecured note of $90,000. The indebtedness was incurred by Aqua America in connection with the acquisition of the operations that were purchased from AquaSource, Inc. o In May 2003, the Company issued 2,491,667 shares of common stock in a public offering for proceeds of $33,100, net of expenses. The net proceeds were used to repay short-term debt, including the repayment of $22,000 of indebtedness incurred in connection with the Company's repurchase of 2,017,700 shares of common stock from affiliates of Veolia Environnement, S.A. (formerly Vivendi Environnement, S.A.) in October 2002. In addition, the Company has a shelf registration statement filed with the Securities and Exchange Commission to permit the offering from time to time of shares of common stock and shares of preferred stock in connection with acquisitions. During 2005, 24,684 shares of common stock totaling $675 were issued by the Company to acquire water and wastewater systems. The balance remaining available for use under the acquisition shelf registration as of December 31, 2005 is 2,194,262 shares. The form and terms of any securities issued under these shelf registrations will be determined at the time of issuance. The Board of Directors has authorized the Company to purchase its common stock, from time to time, in the open market or through privately negotiated transactions. The Company has not repurchased any shares under this authorization since 2000. As of December 31, 2005, 548,278 shares remain available for repurchase. The Company has a Dividend Reinvestment and Direct Stock Purchase Plan ("Plan") that allows reinvested dividends to be used to purchase shares of common stock at a five percent discount from the current market value. Under the direct stock purchase program, shares are purchased by investors at market price. The shares issued under the Plan are either original issue shares or shares purchased by the Company's transfer agent in the open-market. During 2005, 2004 and 2003, under the dividend reinvestment portion of the Plan, 401,503, 512,609 and 527,473 original issue shares of common stock were sold providing the Company with proceeds of $8,516, $7,808 and $7,000, respectively. 41
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) The Company reports comprehensive income in accordance with SFAS No. 130, "Reporting Comprehensive Income." Accordingly, the Company's accumulated other comprehensive income is reported in the Common Stockholders' Equity section of the Consolidated Balance Sheets, the Consolidated Statements of Common Stockholders' Equity and the related other comprehensive income is reported in the Consolidated Statements of Income and Comprehensive Income. The Company reports its unrealized gains on securities and minimum pension liability adjustments as other comprehensive income or loss and accumulated other comprehensive income or loss. NET INCOME PER COMMON SHARE AND EQUITY PER COMMON SHARE Basic net income per share is based on the weighted average number of common shares outstanding. Diluted net income per share is based on the weighted average number of common shares outstanding and potentially dilutive shares. The dilutive effect of employee stock options is included in the computation of Diluted net income per share. The following table summarizes the shares, in thousands, used in computing Basic and Diluted net income per share: Years ended December 31, ---------------------------------- 2005 2004 2003 ---------------------------------- Average common shares outstanding during the period for Basic computation 127,364 124,329 117,700 Dilutive effect of employee stock options 1,842 1,381 1,293 ---------------------------------- Average common shares outstanding during the period for Diluted computation 129,206 125,710 118,993 ================================== For the years ended December 31, 2005 and 2003, there were no outstanding employee stock options excluded from the calculation of diluted net income per share as the average market price of the Company's common stock was greater than the options' exercise price. For the year ended December 31, 2004, employee stock options outstanding to purchase 759,867 shares of common stock were excluded from the calculation of diluted net income per share as the options' exercise price was greater than the average market price of the Company's common stock. Equity per common share was $6.30 and $5.88 at December 31, 2005 and 2004, respectively. These amounts were computed by dividing common stockholders' equity by the number of shares of common stock outstanding at the end of each year. SHAREHOLDER RIGHTS PLAN The Company has a Shareholder Rights Plan designed to protect the Company's shareholders in the event of an unsolicited unfair offer to acquire the Company. Each outstanding common share is entitled to one Right which is evidenced by the common share certificate. In the event that any person acquires 20% or more of the outstanding common shares or commences a tender or exchange offer which, if consummated, would result in a person or corporation owning at least 20% of the outstanding common shares of the Company, the Rights will begin to trade independently from the common shares and, if certain circumstances occur, including the acquisition by a person of 20% or more of the outstanding common shares, each Right would then entitle its holder to purchase a number of common shares of the Company at a substantial discount. If the Company is involved in a merger or other business combination at any time after the Rights become exercisable, the Rights will entitle the holder to acquire a certain number of shares of common stock of the acquiring company at a substantial discount. The Rights are redeemable by the Company at a redemption price of $.01 per Right at any time before the Rights become exercisable. The Rights will expire on March 1, 2008, unless previously redeemed. EMPLOYEE STOCK AND INCENTIVE PLAN In May 2004, the 2004 Equity Compensation Plan ("the 2004 Plan") was approved by the shareholders to replace the 1994 Equity Compensation Plan ("the 1994 Plan"), the Company may grant qualified and non-qualified stock options to officers, key employees and consultants. Officers and key employees may also be granted dividend equivalents and restricted stock. Restricted stock may also be granted to non-employee members of the Board of Directors ("Board"). The 2004 Plan authorizes 4,900,000 shares for issuance under the Plan. A maximum of 50% of the shares available for issuance under the 2004 Plan may be issued as restricted stock and the maximum number of shares that may be subject to grants under the plans to any one individual in any one year is 200,000. Awards under the 2004 Plan are, and awards under the 1994 plan were, made by a committee of the Board of Directors. 42
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) Options under the plans were issued at the market price of the stock on the day of the grant. Options are exercisable in installments of 33% annually, starting one year from the date of the grant and expire 10 years from the date of the grant. The following table summarizes stock option transactions for the plans: As of or For the Years Ended December 31, ----------------------------------------------------------------------------------- 2005 2004 2003 --------------------------- -------------------------- -------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price --------------------------- -------------------------- -------------------------- Options: Outstanding, beginning of year 4,066,983 $ 11.22 3,991,228 $ 9.98 3,773,511 $ 9.04 Granted 816,997 18.33 776,867 16.15 818,205 12.74 Terminated (63,900) 15.22 (131,048) 12.47 (20,711) 11.09 Exercised (1,327,717) 8.88 (570,064) 8.96 (579,777) 7.71 --------------------------- -------------------------- -------------------------- Outstanding, end of year 3,492,363 $ 13.70 4,066,983 $ 11.22 3,991,228 $ 9.98 =========================== ========================== ========================== Exercisable, end of year 1,957,079 $ 11.31 2,549,073 $ 9.32 2,341,733 $ 8.26 =========================== ========================== ========================== Options exercised during 2005 ranged in price from $3.42 per share to $16.15 per share. At December 31, 2005, 4,093,297 options under the 2004 Plan were still available for grant, although under the terms of the 2004 Plan, terminated, expired or forfeited grants under the 1994 Plan and shares withheld to satisfy tax withholding requirements under the 1994 Plan may be re-issued under the 2004 Plan. The following table summarizes the price ranges of the options outstanding and options exercisable as of December 31, 2005: Options Outstanding Options Exercisable ---------------------------------------- ---------------------------- Weighted Weighted Weighted Average Average Average Remaining Exercise Exercise Shares Life (years) Price Shares Price ---------------------------------------- ---------------------------- Range of prices: $ 4.30 - 7.99 290,026 3.1 $ 6.40 290,026 $ 6.40 $ 8.00 - 9.99 250,963 2.8 8.35 250,963 8.35 $10.00 - 12.99 1,301,947 6.4 12.20 1,109,069 12.15 $13.00 - 15.99 160,270 7.4 13.75 106,102 13.76 $16.00 - 16.99 680,491 8.3 16.15 200,919 16.15 $17.00 - 18.33 808,666 9.2 18.33 - - ---------------------------------------- ---------------------------- 3,492,363 6.9 $ 13.70 1,957,079 $ 11.31 ======================================== ============================ Under SFAS No. 123 "Accounting for Stock-Based Compensation" and SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure", the Company applied the provisions of APB Opinion No. 25 and provided the pro forma disclosure provisions of this statement. Accordingly, no compensation cost was recognized in the financial statements for stock options that have been granted. Pursuant to the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, pro forma net income available to common stock and earnings per share are presented in the Summary of Significant Accounting Policies - Stock-Based Compensation as if compensation cost for stock options was determined as of the grant date under the fair value method. On January 1, 2006, the Company adopted SFAS No. 123R, "Share-Base Payment" which changes the accounting for the compensation costs for its stock options granted as described in the Summary of Significant Accounting Policies - Recent Accounting Pronouncements. 43
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) Restricted stock awards provide the grantee with the rights of a shareholder, including the right to receive dividends and to vote such shares, but not the right to sell or otherwise transfer the shares during the restriction period. During 2005, 2004 and 2003, 37,751, 45,535 and 26,875 shares of restricted stock were granted with a restriction period ranging from six to 36 months. The value of restricted stock awards, which are "compensatory", is equal to the fair market value of the stock on the date of the grant and is amortized ratably over the restriction period. The company recorded compensation expense related to restricted stock awards of $495, $439 and $369 during 2005, 2004 and 2003, respectively. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS The Company maintains a qualified, defined benefit pension plan that covers a majority of its full-time employees who were hired prior to April 1, 2003. Retirement benefits under the plan are generally based on the employee's total years of service and compensation during the last five years of employment. The Company's policy is to fund the plan annually at a level which is deductible for income tax purposes and which provides assets sufficient to meet its pension obligations. To offset certain limitations imposed by the Internal Revenue Code with respect to payments under qualified plans, the Company has a non-qualified Excess Benefit Plan for Salaried Employees in order to prevent certain employees from being penalized by these limitations. The Company also has non-qualified Supplemental Executive Retirement Plans for certain current and retired employees. The net pension costs and obligations of the qualified and non-qualified plans are included in the tables which follow. Employees hired after April 1, 2003 may participate in a defined contribution plan that provides a Company matching contribution on amounts contributed by participants and an annual profit-sharing contribution based upon a percentage of the eligible participants' compensation. In addition to providing pension benefits, the Company offers certain Postretirement Benefits other than Pensions ("PBOPs") to employees hired before April 1, 2003 and retiring with a minimum level of service. These PBOPs include continuation of medical and prescription drug benefits for eligible retirees and life insurance benefits for certain eligible retirees. The Company funds its gross PBOP cost through various trust accounts. The benefits of retired officers and certain other retirees are paid by the Company and not from plan assets due to limitations imposed by the Internal Revenue Code. The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid in the years indicated: Other Pension Postretirement Benefits Benefits ------------ -------------- Years: 2006 $ 6,866 $ 1,829 2007 7,076 1,950 2008 7,415 2,095 2009 7,911 2,261 2010 8,383 2,442 2011 - 2015 52,787 14,802 In May 2004, the FASB issued FASB Staff Position ("FSP") No. 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003." FSP 106-2 supersedes FSP 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003," which was issued in January 2004 and permitted a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") until more authoritative guidance on the accounting for the federal subsidy was issued. The Company had elected the one-time deferral allowed under FSP 106-1 and as a result adopted FSP 106-2 as required in the third quarter of 2004 and it did not have a material impact on our results of operations or financial position. 44
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) The changes in the benefit obligation and fair value of plan assets, the funded status of the plans and the assumptions used in the measurement of the company's benefit obligation are as follows: Other Pension Benefits Postretirement Benefits ----------------------- ----------------------- 2005 2004 2005 2004 -------- -------- ------- ------- Change in benefit obligation: Benefit obligation at January 1, $171,076 $150,098 $32,804 $29,134 Service cost 4,847 4,312 1,223 1,112 Interest cost 9,805 9,512 1,882 1,825 Plan amendments - 567 (7,047) 6 Actuarial loss 420 12,742 1,317 1,676 Plan participants' contributions - - 584 631 Benefits paid (6,407) (6,155) (1,602) (1,580) -------- -------- ------- ------- Benefit obligation at December 31, 179,741 171,076 29,161 32,804 -------- -------- ------- ------- Change in plan assets: Fair value of plan assets at January 1, 115,292 108,731 16,606 14,391 Actual return on plan assets 7,790 8,535 675 641 Employer contributions 996 4,181 2,678 2,522 Benefits paid (6,407) (6,155) (1,017) (948) -------- -------- ------- ------- Fair value of plan assets at December 31, 117,671 115,292 18,942 16,606 -------- -------- ------- ------- Funded status of plan: Funded status at December 31, 62,070 55,784 10,219 16,198 Unrecognized actuarial loss (42,092) (41,531) (8,537) (6,853) Unrecognized prior service cost (1,687) (2,090) 7,517 527 Unrecognized net transition obligation 809 1,017 (5,624) (6,428) -------- -------- ------- ------- Net amount recognized $ 19,100 $ 13,180 $ 3,575 $ 3,444 ======== ======== ======= ======= The Company's pension plans had an accumulated benefit obligation of $148,629 and $136,851 at December 31, 2005 and 2004, respectively. The following table provides the net liability recognized on the Consolidated Balance Sheets at December 31: Other Pension Benefits Postretirement Benefits -------------------------- --------------------------- 2005 2004 2005 2004 -------------------------- --------------------------- Prepaid benefits cost $ - $ - $ 555 $ 762 Accrued benefit cost (19,100) (13,180) (4,130) (4,206) Additional minimum liability (12,726) (8,928) - - Intangible assets 1,817 2,108 - - Regulatory asset 6,167 4,140 - - Accumulated other comprehensive loss 4,742 2,680 - - -------------------------- --------------------------- Net liability recognized $(19,100) $(13,180) $(3,575) $(3,444) ========================== =========================== 45
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) At December 31, 2005 and 2004, the Company's pension plans had benefit obligations in excess of its plan assets. The following tables provide the projected benefit obligation, the accumulated benefit obligation and fair market value of the plan assets as of December 31,: Projected Benefit Obligation Exceeds the Fair Value of Plan Assets ------------------------------ 2005 2004 ------------------------------ Projected benefit obligation $ 179,741 $ 171,076 Fair value of plan assets 117,671 115,292 Accumulated Benefit Obligation Exceeds the Fair Value of Plan Assets ------------------------------ 2005 2004 ------------------------------ Accumulated benefit obligation $ 148,629 $ 136,851 Fair value of plan assets 117,671 115,292 The following table provides the components of net periodic benefit costs for the years ended December 31,: Other Pension Benefits Postretirement Benefits ---------------------------------- ---------------------------------- 2005 2004 2003 2005 2004 2003 ---------------------------------- ---------------------------------- Service cost $ 4,847 $ 4,312 $ 3,627 $ 1,223 $ 1,112 $ 987 Interest cost 9,805 9,512 8,999 1,882 1,825 1,703 Expected return on plan assets (9,536) (9,169) (7,775) (1,261) (1,086) (917) Amortization of transition obligation (asset) (209) (209) (209) 803 803 803 Amortization of prior service cost 403 419 395 (57) (57) (57) Amortization of actuarial (gain) loss 1,606 1,009 1,282 219 125 62 Amortization of regulatory asset - - - 136 144 136 Capitalized costs (1,847) (1,021) (205) (739) (629) (598) ---------------------------------- ---------------------------------- Net periodic benefit cost $ 5,069 $ 4,853 $ 6,114 $ 2,206 $ 2,237 $ 2,119 ================================== ================================== Accounting for pensions and other postretirement benefits requires 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. Each assumption is reviewed annually with assistance from the Company's actuarial consultant who provides guidance in establishing the assumptions. The assumptions are selected to represent the average expected experience over time and may differ in any one year from actual experience due to changes in capital markets and the overall economy. These differences will impact the amount of pension and other postretirement benefit expense that the Company recognizes. During 2005, the Company undertook a comprehensive study of the key demographic assumptions which impact the obligations and expense for its plans. Based on the study, the Company updated the assumed retirement and turnover rates for the plans to better reflect the recent experience combined with our expectations of future patterns. In addition, the Company has updated the mortality assumptions to reflect a more recent actuarial study of mortality experience and an expectation of future mortality improvements. The net effect of the changes in these assumptions was a decrease of $1,600 in the Company's pension and postretirement benefit obligation measured as of December 31, 2005. 46
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) The significant assumptions related to the Company's pension and other postretirement benefit plans are as follows: Other Pension Benefits Postretirement Benefits --------------------------- --------------------------- 2005 2004 2005 2004 ------------ ------------ ------------ ------------- Weighted-average Assumptions Used to Determine Benefit Obligations as of December 31, Discount rate 5.65% 5.75% 5.65% 5.75% Rate of compensation increase 4.0-5.0% 4.0-5.0% 4.0% 4.0% Assumed Health Care Cost Trend Rates Used to Determine Benefit Obligations as of December 31, Health care cost trend rate n/a n/a 10% 10% Rate to which the cost trend is assumed to decline (the ultimate trend rate) n/a n/a 5% 5% Year that the rate reaches the ultimate trend rate n/a n/a 2011 2010 Weighted-average Assumptions Used to Determine Net Periodic Benefit Costs for Years Ended December 31, Discount rate 5.75% 6.25% 5.75% 6.25% Expected return on plan assets 8.50% 8.50% 6.0-9.0% 6.0-9.0% Rate of compensation increase 4.0-5.0% 4.0-5.0% 4.0% 4.0% Assumed Health Care Cost Trend Rates Used to Determine Net Periodic Benefit Costs for Years Ended December 31, Health care cost trend rate n/a n/a 10% 10% Rate to which the cost trend is assumed to decline (the ultimate trend rate) n/a n/a 5% 5% Year that the rate reaches the ultimate trend rate n/a n/a 2010 2009 n/a - Assumption is not applicable to pension benefits. Assumed health-care trend rates have a significant effect on the expense and liabilities for other postretirement benefit plans. The health care trend rate is based on historical rates and expected market conditions. A one-percentage point change in the expected health-care cost trend rates would have the following effects: 1-Percentage- 1-Percentage- Point Point Increase Decrease ------------ -------------- Effect on the health-care component of the accrued other postretirement benefit obligation $ 614 $ (689) ======== ======== Effect on total service and interest cost components of net periodic postretirement health-care benefit cost $ 70 $ (104) ======== ======== 47
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) The Company's discount rate assumption was determined using a yield curve that was produced from a universe containing over 500 U.S.-issued Aa-graded corporate bonds, all of which were noncallable (or callable with make-whole provisions), and excluding the 10% of the bonds with the highest yields and the 10% with the lowest yields. The discount rate was then developed as the single rate that would produce the same present value as if the Company used spot rates, for various time periods, to discount the projected pension benefit payments. The Company's pension expense and liability (benefit obligations) increases as the discount rate is reduced. A 25 basis-point reduction in this assumption would have increased 2005 pension expense by $660 and the pension liabilities by $7,000. The Company's expected return on assets is determined by evaluating the asset class return expectations with its advisors as well as actual, long-term, historical results of our asset returns. The Company's pension expense increases as the expected return on assets decreases. A 25 basis-point reduction in this assumption would have increased 2005 pension expense by $280. For 2005, the Company used an 8.5% expected return on assets assumption, and will lower this assumption to 8.0% for the calculation of pension expense for 2006. This change was made to reflect a change in the Company's expectations of long-term market returns given the recent decrease in bond yields. The Company believes its actual long-term asset allocation on average will approximate the targeted allocation. The Company's investment strategy is to earn a reasonable rate of return while maintaining risk at acceptable levels through the diversification of investments across and within various asset categories. Investment returns are compared to benchmarks that include the S&P 500 Index, the Lehman Brothers Intermediate Government/Credit Index, and a combination of the two indices. The Pension Committee meets semi-annually to review plan investments and management monitors investment performance quarterly through a performance report prepared by an external consulting firm. The Company's pension plan asset allocation and the target allocation by asset category are as follows: Percentage of Plan 2006 Assets at December 31, Target ----------------------- Allocation 2005 2004 ---------- ------ ------ Asset Category: Equity securities 65% 60% 62% Debt securities 35% 24% 27% Cash 0% 16% 11% ---- ---- ---- Total 100% 100% 100% ==== ==== ==== Equity securities include Aqua America, Inc. common stock in the amounts of $11,121 or 9.5% of total plan assets and $7,373 or 6.4% of total plan assets as of December 31, 2005 and 2004, respectively. The asset allocation for the Company's other postretirement benefit plans and the target allocation by asset category are as follows: Percentage of Plan 2006 Assets at December 31, Target ----------------------- Allocation 2005 2004 ---------- ------ ------ Asset Category: Cash 65% 67% 60% Equity securities 35% 33% 40% ---- ---- ---- Total 100% 100% 100% ==== ==== ==== Minimum funding requirements for qualified defined benefit pension plans are determined by government regulations and not by accounting pronouncements. In accordance with funding rules and the Company's funding policy, during 2006 our pension contribution is expected to be $6,400. The Company's funding of its PBOP cost during 2006 is expected to approximate $2,882. As of December 31, 2005, the Company has an additional minimum liability of $10,909 associated with our defined benefit plan. The additional minimum liability is a result of the accumulated benefit obligation exceeding the fair value of plan assets. 48
AQUA AMERICA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) The portion of the additional minimum liability related to our employees in one of our rate jurisdictions results in the establishment of a regulatory asset of $6,167, as the Company expects recovery of the future, increased pension expense through customer rates. Since the balance of the additional minimum liability of $4,742 may not be recovered through rates, the accounting requirements for recording a regulatory asset are not met and as a result this amount is recorded as accumulated other comprehensive loss through aggregate charges to accumulated other comprehensive income in 2004 and 2005, net of income tax benefits of $1,660. The change in the additional minimum liability from December 31, 2004 to December 31, 2005 resulted from the effect of a decreased discount rate, offset partially by an increase in the pension plan assets during 2005 due to positive equity market performance and pension contributions. The Company has 401(k) savings plans that cover substantially all employees. The Company makes matching contributions that are invested in Aqua America, Inc. common stock based on a percentage of an employee's contribution, subject to certain limitations. The Company's matching contribution, recorded as compensation expense, was $1,236, $1,160 and $921 for the years ended December 31, 2005, 2004 and 2003, respectively. WATER AND WASTEWATER RATES In November 2005, the Company's Pennsylvania operating subsidiary, Aqua Pennsylvania, Inc., filed an application with the Pennsylvania Public Utility Commission ("PAPUC") requesting a $38,800 or 14.4% increase in annual revenues. The application is currently pending before the PAPUC and a final determination is anticipated by August 2006. On August 5, 2004, the PAPUC granted Aqua Pennsylvania, Inc. a $13,800 base rate increase. The rates in effect at the time of the filing included $11,200 in Distribution System Improvement Charges ("DSIC") or 5.0% above the prior base rates. Consequently, the total base rates increased by $25,000 and the DSIC was reset to zero. In May 2004, the Company's operating subsidiary in Texas filed an application with the Texas Commission on Environmental Quality to increase rates by $11,920 over a multi-year period. The application seeks to increase annual revenues in phases and is 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 approximates the requested amount during the first years that the new rates are in effect. The application is currently pending before the Commission and several parties have joined the proceeding to challenge the rate request. The Company commenced billing for the requested rates and implemented the deferral plan in August 2004, in accordance with authorization from the Texas Commission on Environmental Quality in July 2004. The additional revenue billed and collected prior to the final ruling are subject to refund based on the outcome of the ruling. The revenue recognized and the expenses deferred by the Company reflect an estimate of the final outcome of the ruling. As of December 31, 2005, we have deferred $9,486 of expenses and recognized $5,202 of revenue that is subject to refund based on the outcome of the final commission order, which is not expected to be issued prior to December 2006. The Company's other operating subsidiaries were allowed annual rate increases of $5,142 in 2005, $6,673 in 2004 and $1,275 in 2003, represented by twenty-three, fourteen and eight rate decisions, respectively. Revenues from these increases realized in the year of grant were approximately $3,144, $3,995 and $839 in 2005, 2004 and 2003, respectively. Five states in which the Company operates permit water utilities, and in some states wastewater utilities, to add a surcharge to their water or wastewater bills to offset the additional depreciation and capital costs related to infrastructure system replacement and rehabilitation projects completed and placed into service between base rate filings. Currently, Pennsylvania, Illinois, Ohio, Indiana and Missouri allow for the use of infrastructure rehabilitation surcharges. These mechanisms typically adjust periodically based on additional qualified capital expenditures completed or anticipated in a future period. The infrastructure rehabilitation surcharge is capped as a percentage of base rates, generally at 5% to 9% of base rates, and is reset to zero when new base rates that reflect the costs of those additions become effective or when a utility's earnings exceed a regulatory benchmark. Infrastructure rehabilitation surcharges provided revenues in 2005, 2004 and 2003 of $10,186, $7,817 and $8,147, respectively. 49
Selected Quarterly Financial Data (Unaudited) Aqua America, Inc. and Subsidiaries (In thousands of dollars, except per share amounts) First Second Third Fourth Quarter Quarter Quarter Quarter Year --------------------------------------------------------- 2005 - -------------------------------------------------------------------------------------------------- Operating revenues $ 113,988 $ 123,100 $ 136,783 $ 122,908 $ 496,779 Operations and maintenance expense 47,309 50,891 52,666 52,222 203,088 Operating income 42,771 48,593 59,091 46,052 196,507 Net income 18,871 22,218 27,917 22,150 91,156 Basic net income per common share 0.15 0.17 0.22 0.17 0.72 Diluted net income per common share 0.15 0.17 0.21 0.17 0.71 Dividend paid per common share 0.0975 0.0975 0.0975 0.1069 0.3994 Dividend declared per common share 0.0975 0.0975 0.2044 -- 0.3994 Price range of common stock - high 19.37 23.24 29.15 29.22 29.22 - low 17.49 18.03 21.61 22.88 17.49 2004 - -------------------------------------------------------------------------------------------------- Operating revenues $ 99,768 $ 106,524 $ 120,305 $ 115,442 $ 442,039 Operations and maintenance expense 41,831 44,483 46,526 45,505 178,345 Operating income 36,444 40,473 50,997 49,320 177,234 Net income 15,575 17,871 24,087 22,474 80,007 Basic net income per common share 0.13 0.14 0.19 0.18 0.64 Diluted net income per common share 0.12 0.14 0.19 0.18 0.64 Dividend paid per common share 0.09 0.09 0.09 0.0975 0.3675 Dividend declared per common share 0.09 0.09 0.1875 -- 0.3675 Price range of common stock - high 17.14 16.47 16.67 18.48 18.48 - low 15.00 14.24 14.18 15.58 14.18 All per share data as presented has been adjusted for the 2005 4-for-3 common stock split effected in the form of a 33 1/3% stock distribution. High and low prices of the Company's common stock are as reported on the New York Stock Exchange Composite Tape. The cash dividends paid in December 2005 of $0.1069 and December 2004 of $0.0975 were declared in August 2005 and August 2004, respectively. 50
Summary of Selected Financial Data Aqua America, Inc. and Subsidiaries (in thousands of dollars, except per share amounts) - ------------------------------------------------------------------------------------------------------------------------- Years ended December 31, 2005 2004 (a) 2003 (b) 2002 2001 - ------------------------------------------------------------------------------------------------------------------------- PER COMMON SHARE: Net income Basic $ 0.72 $ 0.64 $ 0.60 $ 0.59 $ 0.53 Diluted 0.71 0.64 0.59 0.58 0.52 Cash dividends declared and paid 0.40 0.37 0.34 0.32 0.30 Return on average stockholders' equity 11.7% 11.4% 12.3% 13.9% 13.3% Book value at year end $ 6.30 $ 5.88 $ 5.33 $ 4.35 $ 4.14 Market value at year end 27.30 18.44 16.58 12.36 13.53 - ------------------------------------------------------------------------------------------------------------------------- INCOME STATEMENT HIGHLIGHTS: Operating revenues $ 496,779 $ 442,039 $ 367,233 $ 322,028 $ 307,280 Depreciation and amortization 65,488 58,864 51,463 44,322 40,168 Interest expense, net (c) 49,615 46,375 42,535 39,007 38,637 Income before income taxes 148,069 132,131 116,718 109,252 99,087 Provision for income taxes 56,913 52,124 45,923 42,046 38,976 Net income available to common stock 91,156 80,007 70,785 67,154 60,005 - ------------------------------------------------------------------------------------------------------------------------- BALANCE SHEET HIGHLIGHTS: Total assets $2,626,725 $2,355,374 $2,071,252 $1,716,030 $1,554,483 Property, plant and equipment, net 2,279,950 2,069,812 1,824,291 1,486,703 1,364,282 Common stockholders' equity 811,923 747,231 658,118 492,594 471,930 Long-term debt, including current portion 903,083 834,656 736,052 617,175 531,455 Total debt 1,041,588 909,466 832,511 732,288 641,123 - ------------------------------------------------------------------------------------------------------------------------- ADDITIONAL INFORMATION: Net cash flows from operating activities $ 199,674 $ 173,603 $ 143,373 $ 121,560 $ 102,165 Capital additions 237,462 195,736 163,320 136,164 124,088 Net cash expended for acquisitions of utility systems 11,633 54,300 192,331 8,914 9,517 Dividends on common stock 51,139 45,807 39,917 36,789 34,234 Number of customers served 864,894 835,512 749,491 605,474 587,537 Number of shareholders of common stock 27,054 24,082 22,726 21,389 20,920 Common shares outstanding (000) 128,970 127,180 123,452 113,194 113,977 Employees (full-time) 1,489 1,442 1,260 971 951 - ------------------------------------------------------------------------------------------------------------------------- All per share data as presented has been adjusted for the 2005 4-for-3 common stock split effected in the form of a 33 1/3% stock distribution. (a) 2004 includes a partial year of finanical results for the mid-year acquisition of Heater Utilities, Inc. and certain utility assets of Florida Water Services Corporation. (b) 2003 includes five months of financial results for the AquaSource operations acquired in July 2003. (c) Net of allowance for funds used during construction and interest income. 51
Exhibit 21.1 AQUA AMERICA, INC. AND SUBSIDIARIES The following table lists the significant subsidiaries and other active subsidiaries of Aqua America, Inc. at December 31, 2005: Aqua Pennsylvania, Inc. (Pennsylvania) Aqua Resources, Inc. (Pennsylvania) Aqua Services, Inc. (Delaware) Aqua Ohio, Inc. (Ohio) Aqua Illinois, Inc. (Illinois) Aqua New Jersey, Inc. (New Jersey) Aqua Maine, Inc. (Maine) Aqua North Carolina, Inc. (North Carolina) Aqua Texas, Inc. (Texas) Aqua Indiana, Inc. (Indiana) Aqua Utilities, Inc. (Texas) Aqua Virginia, Inc. (Virginia) Aqua Utilities Florida, Inc. (Florida) Aqua Missouri, Inc. (Missouri) Aqua South Carolina, Inc. (South Carolina) Heater Utilities, Inc. (North Carolina) Aqua New York, Inc. (New York)
Exhibit 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (Nos. 333-61772, 333-42275, 333-104290, 333-122900 and 333-130400), on Form S-4 (No. 333-93243), and on Form S-8 (Nos. 333-61768, 333-70859, 033-52557, 033-53689, 333-26613, 333-81085, 333-107673, 333-113502, 333-116776 and 333-126042) of Aqua America, Inc. of our report dated March 13, 2006 relating to the consolidated financial statements, management's assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting, which appears in the Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K. /s/ PRICEWATERHOUSECOOPERS LLP PRICEWATERHOUSECOOPERS LLP Philadelphia, Pennsylvania March 13, 2006
Exhibit 31.1 CERTIFICATION I, Nicholas DeBenedictis, Chairman, President and Chief Executive Officer of Aqua America, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of Aqua America, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures, and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 13, 2006 NICHOLAS DEBENEDICTIS ----------------------------------------------- Nicholas DeBenedictis Chairman, President and Chief Executive Officer
Exhibit 31.2 CERTIFICATION I, David P. Smeltzer, Senior Vice President - Finance and Chief Financial Officer of Aqua America, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of Aqua America, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures, and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 13, 2006 DAVID P. SMELTZER --------------------------------------------- David P. Smeltzer Senior Vice President - Finance and Chief Financial Officer
Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 In connection with the Annual Report on Form 10-K for the year ended December 31, 2005 of Aqua America, Inc. (the "Company") as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Nicholas DeBenedictis, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. Section 78m(a) or Section 78o(d)); and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. NICHOLAS DEBENEDICTIS - ---------------------------------- Nicholas DeBenedictis Chairman, President and Chief Executive Officer March 13, 2006
Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 In connection with the Annual Report on Form 10-K for the year ended December 31, 2005 of Aqua America, Inc. (the "Company") as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, David P. Smeltzer, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. Section 78m(a) or Section 78o(d)); and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. DAVID P. SMELTZER - ------------------------------ David P. Smeltzer Senior Vice President - Finance and Chief Financial Officer March 13, 2006