Essential Utilities, Inc. - Quarter Report: 2011 June (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON DC 20549

FORM 10-Q

(Mark One)

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

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

Commission File Number 1-6659

AQUA AMERICA, INC.

(Exact name of registrant as specified in its charter)

Pennsylvania		23-1702594
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
762 W. Lancaster Avenue, Bryn Mawr, Pennsylvania		19010 -3489
(Address of principal executive offices)		(Zip Code)

(610) 527-8000

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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of July 22, 2011: 138,405,123

 

 

AQUA AMERICA, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

		Page
Part I — Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheets (unaudited) — June 30, 2011 and December 31, 2010			2
Consolidated Statements of Income and Comprehensive Income (unaudited) - Six Months Ended June 30, 2011 and 2010			3
Consolidated Statements of Income and Comprehensive Income (unaudited) — Three Months Ended June 30, 2011 and 2010			4
Consolidated Statements of Capitalization (unaudited) — June 30, 2011 and December 31, 2010			5
Consolidated Statement of Equity (unaudited) — Six Months Ended June 30, 2011			6
Consolidated Statements of Cash Flow (unaudited) — Six Months Ended June 30, 2011 and 2010			7
Notes to Consolidated Financial Statements (unaudited)			8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 3. Quantitative and Qualitative Disclosures About Market Risk			28
Item 4. Controls and Procedures			28
Part II — Other Information
Item 1. Legal Proceedings			28
Item 1A. Risk Factors			30
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			31
Item 5. Other Information			32
Item 6. Exhibits			32
Signatures			33
Exhibit Index			34
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

Part 1 — Financial Information

Item 1. Financial Statements

AQUA AMERICA, INC. AND SUBSIDIARIES

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

(UNAUDITED)

		June 30,				December 31,
		2011				2010
Assets
Property, plant and equipment, at cost		$	4,616,437			$	4,488,195
Less: accumulated depreciation			1,060,585				1,020,395
Net property, plant and equipment			3,555,852				3,467,800
Current assets:
Cash and cash equivalents			6,917				5,934
Accounts receivable and unbilled revenues, net			93,579				85,881
Income tax receivable			33,600				33,600
Deferred income taxes			20,764				—
Inventory, materials and supplies			11,794				10,616
Prepayments and other current assets			11,375				10,846
Total current assets			178,029				146,877
Regulatory assets			226,875				217,376
Deferred charges and other assets, net			57,237				65,093
Funds restricted for construction activity			134,411				135,086
Goodwill			40,778				40,234
		$	4,193,182			$	4,072,466
Liabilities and Equity
Aqua America stockholders’ equity:
Common stock at $.50 par value, authorized 300,000,000 shares, issued 139,105,938 and 138,449,039 in 2011 and 2010		$	69,552			$	69,223
Capital in excess of par value			676,888				664,369
Retained earnings			477,574				452,470
Treasury stock, at cost, 703,065 and 673,472 shares in 2011 and 2010			(12,980	)			(12,307	)
Accumulated other comprehensive income			522				499
Total Aqua America stockholders’ equity			1,211,556				1,174,254
Noncontrolling interest			581				572
Total equity			1,212,137				1,174,826
Long-term debt, excluding current portion			1,468,525				1,531,976
Commitments and contingencies			—				—
Current liabilities:
Current portion of long-term debt			90,502				28,413
Loans payable			118,884				89,668
Accounts payable			42,708				45,382
Accrued interest			16,930				15,891
Accrued taxes			10,632				16,401
Other accrued liabilities			27,226				27,960
Total current liabilities			306,882				223,715
Deferred credits and other liabilities:
Deferred income taxes and investment tax credits			545,102				478,705
Customers’ advances for construction			66,143				66,966
Regulatory liabilities			39,489				35,921
Other			107,122				116,250
Total deferred credits and other liabilities			757,856				697,842
Contributions in aid of construction			447,782				444,107
		$	4,193,182			$	4,072,466

See notes to consolidated financial statements beginning on page 8 of this report.

AQUA AMERICA, INC. AND SUBSIDIARIES

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

(UNAUDITED)

		Six Months Ended
		June 30,
		2011				2010
Operating revenues		$	359,553			$	338,961
Operating expenses:
Operations and maintenance			137,762				136,911
Depreciation			54,871				53,002
Amortization			3,887				6,486
Taxes other than income taxes			27,211				25,803
			223,731				222,202
Operating income			135,822				116,759
Other expense (income):
Interest expense, net			40,049				36,934
Allowance for funds used during construction			(3,909	)			(3,002	)
Gain on sale of other assets			(259	)			(2,039	)
Income before income taxes			99,941				84,866
Provision for income taxes			32,000				33,500
Net income attributable to common shareholders		$	67,941			$	51,366
Net income attributable to common shareholders		$	67,941			$	51,366
Other comprehensive income, net of tax:
Unrealized holding gain on investments			96				902
Reclassification adjustment for gains reported in net income			(73	)			(1,330	)
Comprehensive income		$	67,964			$	50,938
Net income per common share:
Basic		$	0.49			$	0.38
Diluted		$	0.49			$	0.38
Average common shares outstanding during the period:
Basic			137,971				136,647
Diluted			138,518				136,960
Cash dividends declared per common share		$	0.31			$	0.29

See notes to consolidated financial statements beginning on page 8 of this report.

AQUA AMERICA, INC. AND SUBSIDIARIES

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

(UNAUDITED)

		Three Months Ended
		June 30,
		2011				2010
Operating revenues		$	188,229			$	178,444
Operating expenses:
Operations and maintenance			70,437				69,310
Depreciation			27,578				26,802
Amortization			1,931				3,314
Taxes other than income taxes			13,446				12,943
			113,392				112,369
Operating income			74,837				66,075
Other expense (income):
Interest expense, net			20,106				18,504
Allowance for funds used during construction			(1,932	)			(1,461	)
Gain on sale of other assets			(138	)			(110	)
Income before income taxes			56,801				49,142
Provision for income taxes			19,211				19,287
Net income attributable to common shareholders		$	37,590			$	29,855
Net income attributable to common shareholders		$	37,590			$	29,855
Other comprehensive income, net of tax:
Unrealized holding gain on investments			92				—
Reclassification adjustment for gain reported in net income			(71	)			—
Comprehensive income		$	37,611			$	29,855
Net income per common share:
Basic		$	0.27			$	0.22
Diluted		$	0.27			$	0.22
Average common shares outstanding during the period:
Basic			138,114				136,785
Diluted			138,781				137,012
Cash dividends declared per common share		$	0.155			$	0.145

See notes to consolidated financial statements beginning on page 8 of this report.

AQUA AMERICA, INC. AND SUBSIDIARIES

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

(UNAUDITED)

										June 30,				December 31,
										2011				2010
Aqua America stockholders’ equity:
Common stock, $.50 par value										$	69,552			$	69,223
Capital in excess of par value											676,888				664,369
Retained earnings											477,574				452,470
Treasury stock, at cost											(12,980	)			(12,307	)
Accumulated other comprehensive income											522				499
Total Aqua America stockholders’ equity											1,211,556				1,174,254
Noncontrolling interest											581				572
Total equity											1,212,137				1,174,826
Long-term debt:
Long-term debt of subsidiaries (substantially secured by utility plant):
		Interest Rate Range				Maturity Date Range
		0.00% to 0.99%					2012 to 2034				6,468				6,632
		1.00% to 1.99%					2011 to 2035				26,044				22,758
		2.00% to 2.99%					2019 to 2029				13,904				13,461
		3.00% to 3.99%					2016 to 2030				25,636				26,548
		4.00% to 4.99%					2020 to 2043				367,698				367,854
		5.00% to 5.99%					2012 to 2043				429,512				429,663
		6.00% to 6.99%					2011 to 2036				78,243				78,232
		7.00% to 7.99%					2012 to 2025				29,585				30,155
		8.00% to 8.99%					2021 to 2025				34,111				34,260
		9.00% to 9.99%					2011 to 2026				44,694				44,694
		10.40%					2018				6,000				6,000
											1,061,895				1,060,257
Notes payable to bank under revolving credit agreement, variable rate, due May 2012											62,000				65,000
Unsecured notes payable:
Notes ranging from 4.62% to 4.87%, due 2013 through 2024											193,000				193,000
Notes ranging from 5.01% to 5.95%, due 2014 through 2037											242,132				242,132
											1,559,027				1,560,389
Current portion of long-term debt											90,502				28,413
Long-term debt, excluding current portion											1,468,525				1,531,976
Total capitalization										$	2,680,662			$	2,706,802

See notes to consolidated financial statements beginning on page 8 of this report.

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EQUITY
(In thousands of dollars)

(UNAUDITED)

																		Accumulated
						Capital in												Other
		Common				Excess of				Retained				Treasury				Comprehensive				Noncontrolling
		Stock				Par Value				Earnings				Stock				Income (Loss)				Interest				Total
Balance at December 31, 2010		$	69,223			$	664,369			$	452,470			$	(12,307	)		$	499			$	572			$	1,174,826
Net income			—				—				67,941				—				—				9				67,950
Unrealized holding gain on investments, net of income tax of $52			—				—				—				—				96				—				96
Reclassification adjustment for gain reported in net income, net of income tax of $39			—				—				—				—				(73	)			—				(73	)
Dividends paid			—				—				(42,813	)			—				—				—				(42,813	)
Sale of stock (299,441 shares)			143				5,920				—				325				—				—				6,388
Repurchase of stock (44,014 shares)			—				—				—				(998	)			—				—				(998	)
Equity compensation plan (14,716 shares)			7				(7	)			—				—				—				—				—
Exercise of stock options (357,703 shares)			179				5,388				—				—				—				—				5,567
Stock-based compensation			—				1,727				(24	)			—				—				—				1,703
Employee stock plan tax benefits			—				(509	)			—				—				—				—				(509	)
Balance at June 30, 2011		$	69,552			$	676,888			$	477,574			$	(12,980	)		$	522			$	581			$	1,212,137

See notes to consolidated financial statements beginning on page 8 of this report.

AQUA AMERICA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOW
(In thousands of dollars)

(UNAUDITED)

		Six Months Ended
		June 30,
		2011				2010
Cash flows from operating activities:
Net income attributable to common shareholders		$	67,941			$	51,366
Adjustments to reconcile net income attributable to common shareholders to net cash flows from operating activities:
Depreciation and amortization			58,758				59,488
Deferred income taxes			33,216				4,495
Provision for doubtful accounts			2,202				2,233
Stock-based compensation			1,727				2,159
Gain on sale of utility system			(4,317	)			—
Gain on sale of other assets			(259	)			(2,039	)
Net increase in receivables, inventory and prepayments			(12,806	)			(8,394	)
Net decrease in payables, accrued interest, accrued taxes and other accrued liabilities			(996	)			(6,684	)
Other			(9,522	)			(3,233	)
Net cash flows from operating activities			135,944				99,391
Cash flows from investing activities:
Property, plant and equipment additions, including allowance for funds used during construction of $3,909 and $3,002			(142,844	)			(140,767	)
Acquisitions of utility systems and other, net			(6,533	)			(1,621	)
Additions to funds restricted for construction activity			(119	)			(1,020	)
Release of funds previously restricted for construction activity			794				4,216
Net proceeds from the sale of utility system and other assets			11,498				3,297
Proceeds from note receivable			5,289				580
Other			(383	)			(4,838	)
Net cash flows used in investing activities			(132,298	)			(140,153	)
Cash flows from financing activities:
Customers’ advances and contributions in aid of construction			2,307				4,243
Repayments of customers’ advances			(1,275	)			(4,818	)
Net proceeds of short-term debt			29,216				23,946
Proceeds from long-term debt			22,293				101,329
Repayments of long-term debt			(23,562	)			(50,897	)
Change in cash overdraft position			214				(9,309	)
Proceeds from issuing common stock			6,388				6,188
Proceeds from exercised stock options			5,567				1,411
Stock-based compensation windfall tax benefits			—				117
Repurchase of common stock			(998	)			(527	)
Dividends paid on common stock			(42,813	)			(39,678	)
Net cash flows (used in) from financing activities			(2,663	)			32,005
Net increase (decrease) in cash and cash equivalents			983				(8,757	)
Cash and cash equivalents at beginning of period			5,934				21,869
Cash and cash equivalents at end of period		$	6,917			$	13,112

See notes to consolidated financial statements beginning on page 8 of this report.

AQUA AMERICA, INC. AND SUBSIDIARIES

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

Note 1

Basis of Presentation

The accompanying consolidated balance sheets and statements of capitalization of Aqua America, Inc. and subsidiaries (the “Company”) at June 30, 2011, the consolidated statements of income and comprehensive income for the six and three months ended June 30, 2011 and 2010, the consolidated statements of cash flow for the six months ended June 30, 2011 and 2010, and the consolidated statement of equity for the six months ended June 30, 2011, are unaudited, but reflect all adjustments, consisting of only normal recurring accruals, which are, in the opinion of management, necessary to present fairly the consolidated financial position, the consolidated changes in equity, the consolidated results of operations, and the consolidated cash flow for the periods presented. Because they cover interim periods, the statements and related notes to the financial statements do not include all disclosures and notes normally provided in annual financial statements and, therefore, should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. The results of operations for interim periods may not be indicative of the results that may be expected for the entire year. The December 31, 2010 consolidated balance sheet data presented herein was derived from the Company’s December 31, 2010 audited consolidated financial statements, but does not include all disclosures and notes normally provided in annual financial statements. Certain prior period amounts have been reclassified to conform to the current period presentation.

Note 2

Goodwill

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

		Regulated
		Segment				Other				Consolidated
Balance at December 31, 2010		$	36,113			$	4,121			$	40,234
Goodwill acquired			867				—				867
Reclassifications to utility plant acquisition adjustment			(323	)			—				(323	)
Balance at June 30, 2011		$	36,657			$	4,121			$	40,778

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

AQUA AMERICA, INC. AND SUBSIDIARIES

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

Note 3

Acquisitions

		As part of the Company’s growth-through-acquisition strategy, in July 2011, the Company entered into a definitive agreement with American Water Works Company, Inc. (“American Water”) to purchase all of the stock of the subsidiary of American Water’s regulated water and wastewater operations in Ohio for cash of approximately $88,000 at closing plus certain assumed liabilities, including debt of approximately $16,000. American Water’s Ohio operations serve approximately 57,000 customers. The purchase price is subject to certain adjustments at closing, and closing is conditioned upon the closing of the Company’s sale of its regulated water operations in New York to American Water, and is subject to applicable regulatory approvals. The transaction is expected to close in the first quarter of 2012.
		In June 2011, the Company completed its acquisition of approximately 51 water and five wastewater systems in Texas serving approximately 5,300 customers. The total purchase price consisted of $6,245 in cash. The pro forma effect of the business acquired is not material to the Company’s results of operations.

Note 4

Dispositions

		In July 2011, the Company entered into a definitive agreement with Connecticut Water Service, Inc. to sell its regulated water operations in Maine for cash of approximately $35,800 at closing plus certain assumed liabilities, including debt of approximately $17,500. The purchase price is subject to certain adjustments at closing. This subsidiary is included in the Regulated segment, and as of June 30, 2011, the carrying amount of Maine’s assets and liabilities were $57,340 and $39,501, respectively. The Company’s Maine operations serve approximately 16,000 customers. The sale is conditioned, among other things, on the receipt of regulatory approvals, and is expected to close in the first quarter of 2012. In the third quarter, the Company will recognize additional income tax expense of approximately $5,000 for the additional deferred tax liabilities that arise from the difference between the stock and tax basis of the Company’s investment in its Aqua Maine subsidiary. The completion of this transaction will conclude the Company’s operations in Maine.
		In July 2011, the Company entered into a definitive agreement with American Water to sell its regulated water operations in New York for cash of approximately $42,000 at closing plus certain assumed liabilities, including debt of approximately $23,000. This subsidiary is included in the Regulated segment, and as of June 30, 2011, the carrying amount of New York’s assets and liabilities were $105,801 and $63,905, respectively. In the third quarter, the Company will recognize additional income tax expense of approximately $2,500 for the additional deferred tax liabilities that arise from the difference between the stock and tax basis of the Company’s investment in its Aqua New York subsidiary. The Company’s New York operations serve approximately 51,000 customers. The purchase price is subject to certain adjustments at closing, and closing is conditioned upon the closing of the Company’s acquisition of American Water’s regulated water and wastewater operations in Ohio, and is subject to applicable regulatory approvals. The sale is expected to close in the first quarter of 2012. The completion of this transaction will conclude the Company’s operations in New York.

AQUA AMERICA, INC. AND SUBSIDIARIES

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

		Based on an assessment of the sale prices and the carrying values of the Company’s planned dispositions of its Maine and New York operations, there is no anticipated impairment expected to be recognized as a result of the sale agreements.
		In June 2011, the Company sold a water and wastewater utility system for net proceeds of $4,106. The sale resulted in the recognition of a gain on the sale, net of expenses, of $1,580 in the second quarter of 2011, and is reported in the consolidated statements of income and comprehensive income as a reduction to operations and maintenance expense. As of June 30, 2011, an additional amount of contingent gain has been deferred pending the final regulatory treatment afforded to such item.
		In May 2011, the Company sold its regulated water and wastewater operations in Missouri for net proceeds of $3,225. This sale of the Company’s Missouri operations concluded the bulk of our regulated utility operations in Missouri.
		In January 2011, the Company sold a water and wastewater utility system in Texas for net proceeds of $3,118. The sale resulted in the recognition of a gain on the sale of these assets, net of expenses, of $2,452. The gain is reported in the consolidated statements of income and comprehensive income as a reduction to operations and maintenance expense.
		The City of Fort Wayne, Indiana (the “City”) has authorized the acquisition by eminent domain of the northern portion of the utility system of one of the operating subsidiaries that the Company acquired in connection with the AquaSource acquisition in 2003. In 2008, the Company reached a settlement with the City to transition the northern portion of the system in 2008 upon receipt of the City’s initial valuation payment of $16,911. The settlement agreement specifically stated that the final valuation of the northern portion of the Company’s system will be determined through a continuation of the legal proceedings that were filed challenging the City’s valuation. On February 12, 2008, the Company turned over the northern portion of the system to the City upon receipt of the initial valuation payment. The proceeds received by the Company are in excess of the book value of the assets relinquished. No gain has been recognized due to the contingency over the final valuation of the assets. Once the contingency is resolved and the asset valuation is finalized, through the finalization of the litigation between the Company and the City of Fort Wayne, the amounts deferred will be recognized in the Company’s consolidated income statement. On March 16, 2009, oral argument was held on certain procedural aspects with respect to the valuation evidence that may be presented and whether the Company is entitled to a jury trial. On October 12, 2010, the Wells County Indiana Circuit Court ruled that the Company is not entitled to a jury trial, and that the Wells County judge should review the City of Fort Wayne Board of Public Works’ assessment based upon a “capricious, arbitrary or an abuse of discretion” standard. The Company disagreed with the Court’s decision and as such on November 11, 2010, requested that the Wells County

AQUA AMERICA, INC. AND SUBSIDIARIES

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

Indiana Circuit Court certify those issues for an interim appeal. The Wells County Indiana Circuit Court granted that request and on March 7, 2011, the Indiana Court of Appeals granted the Company’s request to review the decision of those issues on appeal. On July 6, 2011, the Company filed its appeal with the Indiana Court of Appeals. Depending upon the outcome of all of the legal proceeding the Company may be required to refund a portion of the initial valuation payment, or may receive additional proceeds. The northern portion of the utility system relinquished represents approximately 0.4% of the Company’s total assets.

Note 5

Fair Value of Financial Instruments

The carrying amount of current assets and liabilities that are considered financial instruments approximates their fair value as of the dates presented. The carrying amount and estimated fair value of the Company’s long-term debt are as follows:

		June 30,				December 31,
		2011				2010
Carrying Amount		$	1,559,027			$	1,560,389
Estimated Fair Value			1,586,315				1,483,816

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 $66,143 as of June 30, 2011, and $66,966 as of December 31, 2010. 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 2026 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.

AQUA AMERICA, INC. AND SUBSIDIARIES

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

Note 6

Net Income per Common Share

Basic net income per common share is based on the weighted average number of common shares outstanding. Diluted net income per common share is based on the weighted average number of common shares outstanding and potentially dilutive shares. The dilutive effect of employee stock-based compensation is included in the computation of diluted net income per common share. The dilutive effect of stock-based compensation is calculated using the treasury stock method and expected proceeds upon exercise or issuance of the stock-based compensation. The following table summarizes the shares, in thousands, used in computing basic and diluted net income per common share:

		Six Months Ended								Three Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Average common shares outstanding during the period for basic computation			137,971				136,647				138,114				136,785
Dilutive effect of employee stock-based compensation			547				313				667				227
Average common shares outstanding during the period for diluted computation			138,518				136,960				138,781				137,012

		For the six and three months ended June 30, 2011, employee     stock options to purchase 933,800 shares of common stock, were excluded from the calculations of diluted net income per share as the calculated proceeds from the options’ exercise were greater than the average market price of the Company’s common stock during these periods. For the six and three months ended June 30, 2010, employee stock options to purchase 2,665,445 shares of common stock, were excluded from the calculations of diluted net income per share as the calculated proceeds from the options’ exercise were greater than the average market price of the Company’s common stock during these periods.

Note 7

Stock-based Compensation

Under the Company’s 2009 Omnibus Equity Compensation Plan (the “2009 Plan”), as approved by the Company’s shareholders to replace the 2004 Equity Compensation Plan (the “2004 Plan”), stock options, stock units, stock awards, stock appreciation rights, dividend equivalents, and other stock-based awards may be granted to employees, non-employee directors, and consultants and advisors. The 2009 Plan authorizes 5,000,000 shares for issuance under the plan. A maximum of 50% of the shares available for issuance under the 2009 Plan may be issued as restricted stock and the maximum number of shares that may be subject to grants under the Plan to any one individual in any one year is 200,000. Awards under the 2009 Plan are made by a committee of the Board of Directors. At June 30, 2011, 4,149,814 shares underlying stock-based compensation awards were still available for grants under the 2009 Plan. No further grants may be made under the 2004 Plan.

AQUA AMERICA, INC. AND SUBSIDIARIES

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

Performance Share Units — A performance share unit (“PSU”) represents the right to receive a share of the Company’s common stock if specified performance goals are met over the three year performance period specified in the grant, subject to certain exceptions through the three year vesting period. Each grantee is granted a target award of PSUs, and may earn between 0% and 200% of the target amount depending on the Company’s performance against the performance goals. During the six and three months ended June 30, 2011, the Company recorded stock-based compensation related to PSUs as a component of operations and maintenance expense of $361, and $260, respectively. The following table summarizes nonvested PSU transactions for the six months ended June 30, 2011:

		Number				Weighted
		of				Average
		Share Units				Fair Value
Nonvested share units at beginning of period			—			$	—
Granted			109,375				24.38
Performance criteria adjustment			14,027				24.38
Forfeited			(1,475	)			24.38
Vested			—				—
Share unit awards issued			—				—
Nonvested share units at end of period			121,927			$	24.38

The fair value of PSUs was estimated at the grant date based on the probability of satisfying the performance conditions associated with the PSUs using the Monte Carlo valuation method. The per unit weighted-average fair value at the date of grant for PSUs granted during the six months ended June 30, 2011 was $24.38. The fair value of each PSU grant is amortized into compensation expense on a straight-line basis over their respective vesting periods, which range from 24 to 36 months. The accrual of compensation costs is based on our estimate of the final expected value of the award, and is adjusted as required. The Company assumes that forfeitures will be minimal, and recognizes forfeitures as they occur, which results in a reduction in compensation expense. The recording of compensation expense for PSUs has no impact on net cash flows.

AQUA AMERICA, INC. AND SUBSIDIARIES

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

Restricted Stock Units — A restricted stock unit (“RSU”) represents the right to receive a share of the Company’s common stock. RSUs are eligible to be earned at the end of a specified restricted period, generally three years, beginning on the date of grant. During the six and three months ended June 30, 2011, the Company recorded stock-based compensation related to awards of RSUs as a component of operations and maintenance expense of $141, and $102, respectively. The Company assumes that forfeitures will be minimal, and recognizes forfeitures as they occur, which results in a reduction in compensation expense. The following table summarizes nonvested RSU transactions for the six months ended June 30, 2011:

		Number				Weighted
		of				Average
		Stock Units				Fair Value
Nonvested stock units at beginning of period			—			$	—
Granted			44,342				22.21
Vested			—				—
Forfeited			—				—
Nonvested stock units at end of period			44,342			$	22.21

Stock Options — The fair value of stock options is estimated at the grant date using the Black-Scholes option-pricing model. The following table provides compensation costs for stock-based compensation related to stock options granted in prior periods:

		Six months ended June 30,								Three months ended June 30,
		2011				2010				2011				2010
Stock-based compensation for stock options within operations and maintenance expenses		$	769			$	1,013			$	329			$	519
Income tax benefit			420				301				46				149

There were no stock options granted during the six months ended June 30, 2011. During the second quarter of 2011, the Company recorded an adjustment related to its historical stock option forfeitures that resulted in a favorable adjustment to compensation expense of $644 and additional income tax expense of $52.

AQUA AMERICA, INC. AND SUBSIDIARIES

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

The following table summarizes stock option transactions for the six months ended June 30, 2011:

						Weighted				Weighted
						Average				Average				Aggregate
						Exercise				Remaining				Intrinsic
		Shares				Price				Life (years)				Value
Options:
Outstanding at beginning of period			3,839,197			$	19.54
Granted			—
Forfeited			(12,356	)			18.56
Expired			(10,796	)			23.13
Exercised			(357,703	)			15.56
Outstanding at end of period			3,458,342			$	19.95				5.4			$	10,975
Exercisable at end of period			2,973,498			$	20.28				4.9			$	8,997

Restricted Stock — During the six months ended June 30, 2011 and 2010, the Company recorded stock-based compensation related to restricted stock awards as a component of operations and maintenance expense in the amounts of $1,100 and $1,144, respectively. During the three months ended June 30, 2011 and 2010, the Company recorded stock-based compensation related to restricted stock awards as a component of operations and maintenance expense in the amounts of $711 and $692, respectively. The following table summarizes nonvested restricted stock transactions for the six months ended June 30, 2011:

		Number				Weighted
		of				Average
		Shares				Fair Value
Nonvested shares at beginning of period			233,387			$	17.62
Granted			16,000				22.44
Vested			(85,204	)			18.63
Forfeited			(1,824	)			17.23
Nonvested share units at end of period			162,359			$	17.57

AQUA AMERICA, INC. AND SUBSIDIARIES

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

Note 8

Pension Plans and Other Postretirement Benefits

The Company maintains qualified defined benefit pension plans, nonqualified pension plans and other postretirement benefit plans for certain of its employees. The net periodic benefit cost is based on estimated values and an extensive use of assumptions about the discount rate, expected return on plan assets, the rate of future compensation increases received by the Company’s employees, mortality, turnover, and medical costs. The following tables provide the components of net periodic benefit costs:

		Pension Benefits
		Six Months Ended								Three Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Service cost		$	2,087			$	2,344			$	1,044			$	1,172
Interest cost			5,928				6,440				2,964				3,220
Expected return on plan assets			(5,191	)			(5,592	)			(2,596	)			(2,796	)
Amortization of prior service cost			87				70				43				35
Amortization of actuarial loss			2,033				2,060				1,016				1,030
Capitalized costs			(1,808	)			(1,685	)			(951	)			(888	)
Settlement charge			—				884				—				884
Net periodic benefit cost		$	3,136			$	4,521			$	1,520			$	2,657

						Other
		Postretirement Benefits
		Six Months Ended								Three Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Service cost		$	751			$	610			$	376			$	305
Interest cost			1,623				1,240				812				620
Expected return on plan assets			(1,243	)			(924	)			(621	)			(462	)
Amortization of transition obligation			69				52				34				26
Amortization of prior service cost			(178	)			(134	)			(89	)			(67	)
Amortization of actuarial loss			411				342				206				171
Amortization of regulatory asset			68				68				34				34
Capitalized costs			(343	)			(250	)			(188	)			(129	)
Net periodic benefit cost		$	1,158			$	1,004			$	564			$	498

The Company made cash contributions of $16,540 to its defined benefit pension plans during the first six months of 2011, and intends to make cash contributions of $600 to the plans during the remainder of 2011. In addition, the Company expects to make cash contributions of $2,012 for the funding of its other postretirement benefit plans during the remainder of 2011.

AQUA AMERICA, INC. AND SUBSIDIARIES

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

Note 9

Water and Wastewater Rates

During the first six months of 2011, the Company’s operating divisions in Ohio, Pennsylvania, and Indiana, were granted base rate increases designed to increase total operating revenues on an annual basis by $3,421.

Note 10

Taxes Other than Income Taxes

The following table provides the components of taxes other than income taxes:

		Six Months Ended								Three Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Property		$	13,852			$	13,039			$	6,781			$	6,513
Capital stock			1,773				1,791				892				924
Gross receipts, excise and franchise			4,937				4,680				2,620				2,459
Payroll			3,940				3,748				1,621				1,600
Other			2,709				2,545				1,532				1,447
Total taxes other than income		$	27,211			$	25,803			$	13,446			$	12,943

Note 11

Segment Information

The Company has identified thirteen operating segments and has one reportable segment named the “Regulated” segment. The reportable segment is comprised of twelve operating segments for the Company’s water and wastewater regulated utility companies which are organized by the states where we provide these services. In addition, one segment is not quantitatively significant to be reportable and is comprised of the businesses that provide on-site septic tank pumping, sludge hauling services and certain other non-regulated water and wastewater services. This segment is included as a component of “Other” in the tables below. Also included in “Other” are corporate costs that have not been allocated to the Regulated segment and intersegment eliminations.

AQUA AMERICA, INC. AND SUBSIDIARIES

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

The following tables present the Company’s segment information:

		Three Months Ended												Three Months Ended
		June 30, 2011												June 30, 2010
		Regulated				Other				Consolidated				Regulated				Other				Consolidated
Operating revenues		$	184,956			$	3,273			$	188,229			$	175,593			$	2,851			$	178,444
Operations and maintenance expense			68,024				2,413				70,437				66,523				2,787				69,310
Depreciation			28,112				(534	)			27,578				27,179				(377	)			26,802
Operating income			73,849				988				74,837				66,038				37				66,075
Interest expense, net of AFUDC			17,087				1,087				18,174				16,342				701				17,043
Gain on sale of other assets			23				115				138				110				—				110
Income tax			19,338				(127	)			19,211				20,009				(722	)			19,287
Net income attributable to common shareholders			37,447				143				37,590				29,797				58				29,855

		Six Months Ended												Six Months Ended
		June 30, 2011												June 30, 2010
		Regulated				Other				Consolidated				Regulated				Other				Consolidated
Operating revenues		$	353,221			$	6,332			$	359,553			$	333,599			$	5,362			$	338,961
Operations and maintenance expense			134,283				3,479				137,762				132,581				4,330				136,911
Depreciation			55,764				(893	)			54,871				53,784				(782	)			53,002
Operating income			133,179				2,643				135,822				115,889				870				116,759
Interest expense, net of AFUDC			34,095				2,045				36,140				32,565				1,367				33,932
Gain (loss) on sale of other assets			98				161				259				(7	)			2,046				2,039
Income tax			31,989				11				32,000				33,853				(353	)			33,500
Net income attributable to common shareholders			67,193				748				67,941				49,464				1,902				51,366
Capital expenditures			141,967				877				142,844				140,500				267				140,767

		June 30,				December 31,
		2011				2010
Total assets:
Regulated			4,088,525				3,991,493
Other and eliminations			104,657				80,973
Consolidated		$	4,193,182			$	4,072,466

AQUA AMERICA, INC. AND SUBSIDIARIES

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

Note 12

Commitments and Contingencies

The Company is routinely involved in various disputes, claims, lawsuits and other regulatory and legal matters, including both asserted and unasserted legal claims, in the ordinary course of business. The status of each such matter, referred to herein as a loss contingency, is reviewed and assessed in accordance with applicable accounting rules regarding the nature of the matter, the likelihood that a loss will be incurred, and the amounts involved. As of June 30, 2011, the aggregate amount of $11,106 is accrued for loss contingencies and is reported in the Company’s consolidated balance sheet as other accrued liabilities and other liabilities. These accruals represent management’s best estimate of probable loss (as defined in the accounting guidance) for loss contingencies or the low end of a range of losses if no single probable loss can be estimated. For some loss contingencies, the Company is unable to estimate the amount of the probable loss or range of probable losses. While the final outcome of these loss contingencies cannot be predicted with certainty, and unfavorable outcomes could negatively impact the Company, at this time in the opinion of management, the final resolution of these matters are not expected to have a material adverse effect on the Company’s financial position, results of operations or cash flows. Further, the Company has insurance coverage for certain of these loss contingencies, and as of June 30, 2011, estimates that approximately $1,244 of the amount accrued for these matters are probable of recovery through insurance, which amount is also reported in the Company’s consolidated balance sheet as deferred charges and other assets, net.

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. During the second quarter of 2011, the Company received notice of increased rates on certain purchase water agreements. As a result of these increases, the Company’s estimated annual commitments related to all of such purchases through 2015 are expected to average $12,274 and the aggregate of the commitments for the years remaining approximates $49,697.

Note 13

Income Taxes

As of June 30, 2011, the Company recorded a deferred tax asset for a Federal net operating loss (“NOL”) carryforward of $55,400, and for the Company’s Pennsylvania operating subsidiary, a state NOL of $13,743. The Company believes the Federal and state NOL carryforwards are more likely than not to be recovered and require no valuation allowance. The Company’s Federal and state NOL carryforwards do not begin to expire until 2030 and 2031, respectively.

AQUA AMERICA, INC. AND SUBSIDIARIES

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

Note 14

Recent Accounting Pronouncements

There have been no recent accounting pronouncements or changes in accounting pronouncements that the Company has adopted that would have a material impact on the Company’s consolidated results of operations or consolidated financial position during the six months ended June 30, 2011.

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)

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking Statements

This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Quarterly Report contain, in addition to historical information, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements address, among other things: our belief in our ability to renew our short-term lines of credit; the impact and the actions we may need to take if we are unable to obtain sufficient capital; the projected impact of various legal proceedings; the projected effects of recent accounting pronouncements; prospects, plans, objectives, expectations and beliefs of management, as well as information contained in this report where statements are preceded by, followed by or include the words “believes,” “expects,” “anticipates,” “plans,” “future,” “potential,” “probably,” “predictions,“intends,” “will,” “continue” or the negative of such terms or similar expressions. Forward-looking statements are based on a number of assumptions concerning future events, and are subject to a number of risks, uncertainties and other factors, many of which are outside our control, which could cause actual results to differ materially from those expressed or implied by such statements. These risks and uncertainties include, among others: the effects of regulation, abnormal weather, changes in capital requirements and funding, acquisitions, changes to the capital markets, and our ability to assimilate acquired operations, as well as those risks, uncertainties and other factors discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 under the captions “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in such report. As a result, readers are cautioned not to place undue reliance on any forward-looking statements. We undertake no obligation to update or revise forward-looking statements, whether as a result of new information, future events or otherwise.

General Information

Nature of Operations - Aqua America, Inc. (“we” or “us”), a Pennsylvania corporation, is the holding company for regulated utilities providing water or wastewater services to what we estimate to be approximately 3 million people in Pennsylvania, Ohio, North Carolina, Illinois, Texas, New Jersey, New York, Florida, Indiana, Virginia, Maine, and Georgia. Our largest operating subsidiary, Aqua Pennsylvania, Inc., provides water or wastewater services to approximately one-half of the total number of people we serve, who are located in the suburban areas in counties north and west of the City of Philadelphia and in 25 other counties in Pennsylvania. Our other subsidiaries provide similar services in 11 other states. In July 2011, we entered into a definitive agreement to purchase all of American Water Works Company, Inc’s regulated operations in Ohio (the “Ohio acquisition”), which serve approximately 57,000 customers, and to simultaneously sell our regulated water and wastewater operations in New York, which serve approximately 51,000 customers. Also, in July 2011, we entered into a definitive agreement to sell our operations in Maine, which serve approximately 16,000 customers. The Ohio acquisition will be financed by the issuance of long-term and / or short-term debt. The proceeds from the

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 of our operations in New York and Maine will be used to paydown a portion of our short-term debt and other general corporate purposes. These transactions are conditioned, among other things, on the receipt of regulatory approvals, and are expected to close in the first quarter of 2012. The completion of these transactions will conclude our operations in New York and Maine. In December 2010, we entered into a definitive agreement to sell our regulated water and wastewater operations in Missouri, which served approximately 3,900 customers. The sale of our utility in Missouri closed in May 2011, concluding the bulk of our utility operations in Missouri. In addition, we provide water and wastewater service through operating and maintenance contracts with municipal authorities and other parties close to our utility companies’ service territories as well as sludge hauling, septage and grease services, backflow prevention services, and certain other non-regulated water and wastewater services.

Aqua America, Inc., which prior to its name change in 2004 was known as Philadelphia Suburban Corporation, was formed in 1968 as a holding company for its primary subsidiary, Aqua Pennsylvania, Inc., formerly known as Philadelphia Suburban Water Company. In the early 1990s, we embarked on a growth-through-acquisition strategy focused on water and wastewater operations. Our most significant transactions to date have been the merger with Consumers Water Company in 1999, the acquisition of the regulated water and wastewater operations of AquaSource, Inc. in 2003, the acquisition of Heater Utilities, Inc. in 2004, and the acquisition of New York Water Service Corporation in 2007. Since the early 1990s, our business strategy has been primarily directed toward the regulated water and wastewater utility industry and has extended our regulated operations from southeastern Pennsylvania to include operations in 11 other states.

Financial Condition

During the first six months of 2011, we had $142,844 of capital expenditures, and repaid debt and made sinking fund contributions and other loan repayments of $23,562. The capital expenditures were related to improvements to treatment plants, new and rehabilitated water mains, tanks, hydrants, and service lines, well and booster improvements, and other enhancements and improvements.

At June 30, 2011, we had $6,917 of cash and cash equivalents compared to $5,934 at December 31, 2010. During the first six months of 2011, we used the proceeds from internally generated funds, the sale of other assets, and the sale or issuance of common stock through our equity compensation plan and dividend reinvestment plan, to fund the cash requirements discussed above and to pay dividends.

At June 30, 2011, our $95,000 unsecured revolving credit facility, which expires in May 2012, had $15,399 available for borrowing. At June 30, 2011, we had short-term lines of credit of $167,000, of which $48,116 was available. On July 1, 2011, we did not renew one of our credit lines in the amount of $2,500, which expired on July 1, 2011, as it was no longer needed. One of our short-term lines of credit is an Aqua Pennsylvania $100,000 364-day unsecured revolving credit facility with three banks, which is used to provide working capital, and as of June 30, 2011, $7,857 was available.

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 short-term lines of credit of $167,000 are subject to renewal on an annual basis. Although we believe we will be able to renew these facilities, there is no assurance that they will be renewed, or what the terms of any such renewal will be. The United States credit and liquidity crisis that occurred in 2008 and 2009 caused substantial volatility in capital markets, including credit markets and the banking industry, generally reduced the availability of credit from financing sources, and could re-occur in the future. If in the future, our credit facilities are not renewed or our short-term borrowings are called for repayment, we would have to seek alternative financing sources; however, there can be no assurance that these alternative financing sources would be available on terms acceptable to us. In the event we are not able to obtain sufficient capital, we may need to reduce our capital expenditures and our ability to pursue acquisitions that we may rely on for future growth could be impaired.

The Company’s consolidated balance sheet historically has had a negative working capital position whereby routinely our current liabilities exceed our current assets. Management believes that internally generated funds along with existing credit facilities and the proceeds from the issuance of long-term debt and common stock will be adequate to provide sufficient working capital to maintain normal operations and to meet our financing requirements for at least the next twelve months.

Results of Operations

Analysis of First Six Months of 2011 Compared to First Six Months of 2010

Revenues increased $20,592 or 6.1% primarily due to additional revenues associated with increased water and wastewater rates of $19,956, and additional water and wastewater revenues of $1,289 associated with a larger customer base due to acquisitions.

Operations and maintenance expenses increased by $851 or 0.6% primarily due to increased water production costs of $2,723, an increase in postretirement benefits expenses of $1,396, increases in operating costs associated with acquired utility systems of $821, increases in fuel costs for our service vehicles of $475, and normal increases in other operating costs. Offsetting these increases were the gains on the sales of our utility systems recognized during the first six months of 2011 of $4,312, the effect of the write-off in the first quarter of 2010 of previously deferred regulatory expenses of $1,011, and decreased insurance expense of $734. The increase in water production costs is primarily due to an increase in the cost of purchased water.

Depreciation expense increased $1,869 or 3.5% due to the utility plant placed in service since June 30, 2010.

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)

Amortization decreased $2,599 primarily due to the additional expense recognized in the first six months of 2010 of $3,431 resulting from the recovery of our costs associated with a completed rate filing in Texas, offset by the amortization of the costs associated with, and other costs being recovered in, various rate filings.

Taxes other than income taxes increased by $1,408 or 5.5% primarily due to an increase in property taxes of $813 and an increase in gross receipts, excise and franchise taxes of $257. The increase in property taxes is attributable to an increase in recoverable expenses associated with a rate award received in February 2010 for one of our states. In that state, recovery of the property taxes began with the conclusion of the most recent rate proceeding, whereas previously these taxes had been deferred pending the inclusion in future rates. The increase in gross receipts, excise and franchise taxes is attributable to an increase in revenue.

Interest expense increased by $3,115 or 8.4% primarily due to additional borrowings to finance capital projects, offset partially by decreased interest rates on long-term debt.

Allowance for funds used during construction (“AFUDC”) increased by $907 primarily due to an increase in the average balance of proceeds held from tax-exempt bond issuances that are restricted to funding certain capital projects.

Gain on sale of other assets totaled $259 in the first half of 2011 and $2,039 in the first half of 2010. The decrease of $1,780 is principally due to a gain on the sale of an investment in the first half of 2010.

Our effective income tax rate was 32.0% in the first half of 2011 and 39.5% in the first half of 2010. The effective income tax rate decreased as a result of the recognition in 2011 of the net state income tax benefit of $7,811 associated with 100% bonus depreciation for qualifying capital additions.

Net income attributable to common shareholders increased by $16,575 or 32.3%, in comparison to the same period in 2010 primarily as a result of the factors described above. On a diluted per share basis, earnings increased $0.11 reflecting the change in net income attributable to common shareholders and a 1.1% increase in the average number of common shares outstanding. If earnings were adjusted to exclude the net state income tax benefit associated with 100% bonus depreciation, a non-GAAP financial measure, earnings would have increased by $0.05 per share, as compared to the first half of 2010. The increase in the number of shares outstanding is primarily a result of the additional shares sold or issued through our equity compensation plan and dividend reinvestment plan.

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

Analysis of Second Quarter of 2011 Compared to Second Quarter of 2010

Revenues increased $9,785 or 5.5% primarily due to additional revenues associated with increased water and wastewater rates of $7,905, and additional water and wastewater revenues of $716 associated with a larger customer base due to acquisitions.

Operations and maintenance expenses increased by $1,127 or 1.6% primarily due to increased water production costs of $1,343, an increase in postretirement benefits expenses of $671, increases in operating costs associated with acquired utility systems of $363, increases in fuel costs for our service vehicles of $339, and normal increases in other operating costs. Offsetting these increases were the gains on the sales of our utility systems recognized in the second quarter of 2011 of $1,860. The increase in water production costs is primarily due to an increase in the cost of purchased water.

Depreciation expense increased $776 or 2.9% due to the utility plant placed in service since June 30, 2010.

Amortization decreased $1,383 primarily due to the additional expense recognized in the second quarter of 2010 of $1,796 resulting from the recovery of our costs associated with a completed rate filing in Texas, offset by the amortization of the costs associated with, and other costs being recovered in, various rate filings.

Taxes other than income taxes increased by $503 or 3.9% primarily due to an increase in property taxes of $268 and an increase in gross receipts, excise and franchise taxes of $161. The increase in property taxes is attributable to an increase in recoverable expenses associated with a rate award received in February 2010 for one of our states. In that state, recovery of the property taxes began with the conclusion of the most recent rate proceeding, whereas previously these taxes had been deferred pending the inclusion in future rates. The increase in gross receipts, excise and franchise taxes is attributable to an increase in revenue.

Interest expense increased by $1,602 or 8.7% primarily due to additional borrowings to finance capital projects, offset partially by decreased interest rates on long-term debt.

Allowance for funds used during construction (“AFUDC”) increased by $471 primarily due to an increase in the average balance of proceeds held from tax-exempt bond issuances that are restricted to funding certain capital projects.

Gain on sale of other assets totaled $138 in the second quarter of 2011 and $110 in the second quarter of 2010. The increase of $28 is principally due to the timing of sales of land and other property.

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 effective income tax rate was 33.8% in the second quarter of 2011 and 39.2% in the second quarter of 2010. The effective income tax rate decreased as a result of the recognition in 2011 of the net state income tax benefit of $3,483 associated with 100% bonus depreciation for qualifying capital additions.

Net income attributable to common shareholders increased by $7,735 or 25.9%, in comparison to the same period in 2010 primarily as a result of the factors described above. On a diluted per share basis, earnings increased $0.05 reflecting the change in net income attributable to common shareholders and a 1.3% increase in the average number of common shares outstanding. If earnings were adjusted to exclude the net state income tax benefit associated with 100% bonus depreciation, a non-GAAP financial measure, earnings would have increased by $0.03 per share, as compared to the second quarter of 2010. The increase in the number of shares outstanding is primarily a result of the additional shares sold or issued through our equity compensation plan and dividend reinvestment plan.

Impact of Recent Accounting Pronouncements

There have been no recent accounting pronouncements or changes in accounting pronouncements that the Company has adopted that would have a material impact on the Company’s consolidated results of operations or consolidated financial position during the six months ended June 30, 2011.

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)

Non-Generally Accepted Accounting Principle (“GAAP”) Financial Measures

In addition to reporting “net income attributable to common shareholders” and “net income per common share”, U.S. GAAP financial measures, we are presenting below “income attributable to common shareholders before net state income tax benefit associated with 100% bonus depreciation” and “income per common share before net state income tax benefit associated with 100% bonus depreciation”, which are considered non-GAAP financial measures. The Company is providing disclosure of the reconciliation of these non-GAAP measures to their most comparable GAAP financial measures. The Company believes that the non-GAAP financial measures provide investors the ability to measure the Company’s financial operating performance excluding the net state income tax benefit associated with 100% bonus depreciation, which is more indicative of the Company’s ongoing performance, and is more comparable to measures reported by other companies. The Company further believes that the presentation of these non-GAAP financial measures is useful to investors as a more meaningful way to compare the Company’s operating performance against its historical financial results and to assess the underlying profitability of our core business. As currently enacted, 100% bonus depreciation is in effect for qualifying capital additions placed in service from September 8, 2010 through December 31, 2011.

		Six Months Ended								Three Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Net income attributable to common shareholders (GAAP financial measure)		$	67,941			$	51,366			$	37,590			$	29,855
Less: Net state income tax benefit associated with 100% bonus depreciation			7,811				—				3,483				—
Income attributable to common shareholders before net state income tax benefit associated with 100% bonus depreciation (Non-GAAP financial measure)		$	60,130			$	51,366			$	34,107			$	29,855
Net income per common share (GAAP financial measure):
Basic		$	0.49			$	0.38			$	0.27			$	0.22
Diluted		$	0.49			$	0.38			$	0.27			$	0.22
Income per common share before net state income tax benefit associated with 100% bonus depreciation (Non-GAAP financial measure):
Basic		$	0.44			$	0.38			$	0.25			$	0.22
Diluted		$	0.43			$	0.38			$	0.25			$	0.22
Average common shares outstanding:
Basic			137,971				136,647				138,114				136,785
Diluted			138,518				136,960				138,781				137,012

AQUA AMERICA, INC. AND SUBSIDIARIES

Item 3.		Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risks in the normal course of business, including changes in interest rates and equity prices. There have been no significant changes in our exposure to market risks since December 31, 2010. Refer to Item 7A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 for additional information.

Item 4.		Controls and Procedures

(a)

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report are effective such that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.

(b)

Changes in Internal Control over Financial Reporting

No change in our internal control over financial reporting occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II. Other Information

Item 1.		Legal Proceedings

The City of Fort Wayne, Indiana (the “City”) authorized the acquisition by eminent domain of the northern portion of the utility system of one of the Company’s operating subsidiaries in Indiana. In 2008, we reached a settlement agreement with the City to transition this portion of the system in 2008 upon receipt of the City’s initial valuation payment of $16,910,500. The settlement agreement specifically stated that the final valuation of the system will be determined through a continuation of the legal proceedings that were filed challenging the City’s valuation. On February 12, 2008, we turned over the northern portion of the system to the City upon receipt of the initial valuation payment. The proceeds received by the Company are in excess of the book value of the assets relinquished. No gain has been recognized due to the contingency over the final valuation of the assets. Once the contingency is resolved and the asset valuation is finalized, through the finalization of the litigation between the Company and the City of Fort Wayne, the amounts deferred will be recognized in the Company’s consolidated income statement. On March 16, 2009, oral argument was held before the Allen County Circuit Court on certain procedural aspects with respect to the valuation evidence that may be presented and whether we are entitled to a jury trial. On October 12, 2010, the Wells County Indiana Circuit Court ruled that the Company is not entitled to a jury trial, and that the Wells County judge should review the City of Fort Wayne Board of Public Works’ assessment based upon a “capricious, arbitrary or an abuse of discretion” standard. The Company disagreed with the Court’s decision and as such, on November 11, 2010, requested that the Wells County Indiana Circuit Court certify those issues for an interim appeal. The Wells County Circuit Court granted that request and on March 7, 2011, the Indiana Court of Appeals granted the Company’s request to review the decision of those issues on appeal. On July 6, 2011, the Company filed its appeal with the Indiana Court of Appeals. Depending upon the ultimate outcome of all of the legal proceedings we may be required to refund a portion of the initial valuation payment, or may receive additional proceeds. The northern portion of the system relinquished represented approximately 0.50% of Aqua America’s total assets.

AQUA AMERICA, INC. AND SUBSIDIARIES

A lawsuit was filed by a husband and wife who lived in a house abutting a percolation pond at a wastewater treatment plant owned by one of the Company’s subsidiaries, Aqua Utilities Florida, Inc., in Pasco County, Florida. The lawsuit was originally filed in August 2006 in the circuit court for the Sixth Judicial Circuit in and for Pasco County, Florida and has been amended several times by the plaintiffs. The lawsuit alleged our subsidiary was negligent in the design, operation and maintenance of the plant, resulting in bodily injury to the plaintiffs and various damages to their property. Subsequent amendments to the complaint included additional counts alleging trespass, nuisance, and strict liability. A trial of this matter during January 2011 resulted in a judicial dismissal of the count for strict liability and jury verdicts in favor of the Company on the remaining counts. On June 16, 2011, the plaintiffs agreed to dismiss their appeals and to release all claims against our subsidiary and the Company, which resulted in the conclusion of the original plaintiffs’ litigation against our subsidiary. In the third quarter of 2008, approximately thirty-five additional plaintiffs, associated with approximately eight other homes in the area, filed a lawsuit with the same court making similar allegations against our subsidiary with respect to the operation of the facility. No trial date has been set for this lawsuit, but some of these plaintiffs testified in the trial of the original lawsuit in which all allegations were resolved in the Company’s favor. The lawsuit has been submitted to our insurance carriers, who have reserved their rights with respect to various portions of the plaintiffs’ claims. Based on the ultimate outcome of the litigation, we may or may not have insurance coverage for parts or all of the claim. The Company continues to assess this matter and any potential loss. At this time, the Company believes that the estimated amount of any potential loss would not be material to the Company’s consolidated results of operations or consolidated financial condition.

AQUA AMERICA, INC. AND SUBSIDIARIES

In July 2010 one of the Company’s subsidiaries, Aqua Pennsylvania, Inc., received a notice of violation from the Pennsylvania Department of Environmental Protection (the “DEP”). The notice of violation resulted from the subsidiary’s commencement of construction of a water tank prior to receipt of a construction permit from DEP. The permit was subsequently received. On September 29, 2010, the DEP notified the Company of a proposed penalty of $120,000 in connection with the violation. A settlement has been reached with the DEP and the penalty amount was reduced to $80,000 as of August 1, 2011.

Item 1A.		Risk Factors

There have been no material changes to the risks disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010 (“Form 10-K”) under “Part 1, Item 1A — Risk Factors.”

AQUA AMERICA, INC. AND SUBSIDIARIES

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