WTRG

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2004, for Aqua America, Inc. (formerly Philadelphia Suburban Corporation). The company is the largest U.S.-based publicly-traded water utility by number of people served, providing water and wastewater services to over 2.5 million people across 13 states. The reporting period includes the impact of the Heater Utilities, Inc. acquisition (closed June 1, 2004) and the Florida Water Services Corporation asset acquisition (closed June 30, 2004).

Key Financial Metrics

All figures in thousands of dollars, except per share amounts.

Liquidity: As of June 30, 2004, the company had short-term lines of credit of $256,500, with $113,844 available. Management believes internally generated funds and existing credit facilities are adequate to meet financing requirements.

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased 25.9% ($42,424) year-over-year. This was driven primarily by a $35,300 increase in water/sewer revenues from a larger customer base due to acquisitions (AquaSource and Heater) and a $2,840 increase from infrastructure rehabilitation surcharges in Pennsylvania.
• Expense Increases: Operations and maintenance expenses rose 39.9% ($24,621), largely due to acquired operations, increased pension costs, and higher water production expenses. Depreciation increased 19.2% due to new utility plant and acquired assets.
• Profitability: Net income available to common stock increased 17.1% ($4,887). Diluted earnings per share increased 9.1% ($0.03), despite an 8.6% increase in average shares outstanding.
• Debt Structure: Total debt increased significantly due to the assumption of debt in the Heater acquisition ($19,219 long-term, $8,500 short-term) and new issuances ($70,000 unsecured note and $87,000 subsidiary debt) used to refinance existing debt and fund acquisitions.

Outlook, Risks, and Management Commentary

• Acquisitions: The Heater acquisition added over 50,000 customers in North Carolina. The Florida Water Services acquisition (63 systems) is subject to regulatory approval which may take up to a year; the final price may be adjusted based on plant investment determinations.
• Rate Increases:
  • Pennsylvania: A $13,800 base rate increase plus $11,200 in Distribution System Improvement Charges (DSIC) was approved, totaling a $25,000 annual revenue increase, effective August 2004.
  • Texas: An application for an $11,920 annual revenue increase is pending. The Commission authorized billing for these rates in August 2004, subject to refund if the final ruling differs.
  • Illinois & New Jersey: Rate increases approved in April and June 2004 are expected to add approximately $2,261 and $1,047 in annual revenues, respectively.
• Dividends: The quarterly cash dividend on common stock was increased from $0.12 to $0.13 per share, effective with the December 1, 2004 payment.
• Accounting Risks: The company is evaluating the impact of FASB Staff Position No. 106-2 regarding the Medicare Prescription Drug Act, effective September 30, 2004. The final purchase price for the AquaSource acquisition is subject to arbitration, expected to conclude in Q3 2004.

Investor Verification Checklist

• Acquisition Integration: Verify the final purchase price allocation for Heater Utilities and the regulatory approval status for the Florida Water Services acquisition.
• Rate Case Outcomes: Monitor the final ruling on the Texas rate increase application, as revenues billed are subject to refund.
• Debt Refinancing: Review the terms of the new $70,000 unsecured note and $87,000 subsidiary debt to confirm interest rate exposure and maturity profiles.
• Accounting Adjustments: Watch for the impact of FSP 106-2 adoption on postretirement benefit obligations in the Q3 2004 filing.
• Arbitration: Track the resolution of the AquaSource purchase price arbitration to determine if the final price falls within the expected range of $178.4M to $191.8M.