Essential Utilities, Inc. - Quarter Report: 2014 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON DC  20549

FORM 10-Q

(Mark One) 

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

For the quarterly period ended March 31, 2014 

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

For the transition period from_______________ to _______________

Commission File Number 1-6659 

AQUA AMERICA, INC. 

(Exact name of registrant as specified in its charter) 

 

 

(Former Name, former address and former fiscal year, if changed since last report.)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ☒    No ☐

 

Indicate by check mark whether the registrant has submitted electronically 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 ☒    No ☐

 

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

 

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

 

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

April 23,  2014:  177,060,756

  

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TABLE OF CONTENTS

 

 

 

 

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CONSOLIDATED BALANCE SHEETS 

(In thousands of dollars, except per share amounts) 

(UNAUDITED)

 

 

  

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CONSOLIDATED STATEMENTS OF NET INCOME

(In thousands, except per share amounts)

(UNAUDITED)

 

 

 

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 

(In thousands of dollars) 

(UNAUDITED)

 

  

 

 

 

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CONSOLIDATED STATEMENTS OF CAPITALIZATION 

(In thousands of dollars, except per share amounts) 

(UNAUDITED)

 

 

 

  

 

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CONSOLIDATED STATEMENT OF EQUITY 

(In thousands of dollars)

(UNAUDITED)

 

 

 

  

 

 

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CONSOLIDATED STATEMENTS OF CASH FLOW 

(In thousands of dollars) 

(UNAUDITED)

 

 

 

 

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Note 1             Basis of Presentation 

 

The accompanying consolidated balance sheets and statements of capitalization of Aqua America, Inc. and subsidiaries (the “Company”) at March 31, 2014, the consolidated statements of net income and comprehensive income for the three months ended March 31, 2014 and 2013, the consolidated statements of cash flow for the three months ended March 31, 2014 and 2013, and the consolidated statement of equity for the three months ended March 31, 2014 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, 2013.  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, 2013 consolidated balance sheet data presented herein was derived from the Company’s December 31, 2013 audited consolidated financial statements, but does not include all disclosures and notes normally provided in annual financial statements.  All common share, per common share, stock unit, and per stock unit data, for all periods presented, has been adjusted to give effect to the September 1, 2013 five-for-four stock split effected in the form of a 25% stock distribution (see Note 5).  Certain prior period amounts have been reclassified to conform to the reporting of discontinued operations (see Note 4).

   

 

Note 2             Goodwill 

 

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

 

 

 

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The reclassification of goodwill to utility plant acquisition adjustment in the table above 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. 

   

 

 

  

Note 3             Acquisitions

 

In May 2014, the Company entered into an asset purchase agreement for the acquisition of the water and wastewater utility system assets of North Maine Utilities owned by the Village of Glenview, Illinois serving approximately 7,200 customers, for cash at closing of up to $22,000, subject to final adjustment pursuant to the purchase agreement.  Closing of this acquisition is anticipated to occur in mid-year 2015.          

 

In March 2014, the Company acquired the wastewater utility system assets of Penn Township located in Chester County, Pennsylvania serving approximately 800 customers.  The total purchase price consisted of $3,668 in cash. 

 

In March 2013, the Company acquired the water and wastewater utility system assets of Total Environmental Solutions, Inc. located in Clearfield County, Pennsylvania serving approximately 4,200 customers.  The total purchase price consisted of $10,350 in cash. 

 

Note 4             Discontinued Operations and Other Disposition 

 

Discontinued Operations – In September 2012, the Company began to market for sale its water and wastewater operations in Florida, which served approximately 38,000 customers, and the Company’s wastewater treatment facility in Georgia.    In March, April, and December 2013, through five separate sales transactions, the Company completed the sale of its water and wastewater utility systems in Florida, which concluded its regulated operations in Florida.  The Company received total net proceeds from these sales of $88,934 and recognized a gain on sale of $21,178 ($13,766 after-tax), including a first quarter 2013 gain on sale of $6,451 ($4,193 after-tax).  One of the Company’s sales in Florida, which was completed in March 2013, and represented approximately 8% of its customers served in Florida, remains subject to customary regulatory review, for which the Company expects to receive the regulator’s decision by midyear 2014.  If the regulator does not approve this sale, the purchase price would be refunded and the assets sold would revert back to the Company.  On March 12, 2014, the Company completed the sale of its wastewater treatment facility in Georgia.     

 

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 Company’s operating subsidiaries in Indiana (the “Northern Assets”).  In January 2008, the Company reached a settlement with the City to transition the Northern Assets in February 2008 upon receipt

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of the City’s initial valuation payment of $16,911.  The settlement agreement specifically stated that the final valuation of the Northern Assets 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 Assets 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.  The net book value of the Northern Assets has been removed from the consolidated balance sheet and the difference between the net book value and the initial payment received has been deferred and is recorded in other accrued liabilities on the Company’s consolidated balance sheet.  Once the contingency is resolved and the asset valuation is finalized, through the finalization of the litigation between the Company and the City, the amounts deferred will be recognized in the Company’s consolidated statement of net income.  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 appealed the Wells County Indiana Circuit Court’s decision to the Indiana Court of Appeals.  On January 13, 2012, the Indiana Court of Appeals reached a decision upholding the Wells County Indiana Circuit Court decision.  On February 10, 2012, the Company filed a petition for transfer requesting that the Indiana Supreme Court review the matter.  On April 11, 2013, the Indiana Supreme Court ruled that the statute at issue gives the Company the right to a full evidentiary hearing before a jury regarding the value of the assets and remanded the case to the trial court for a proceeding consistent with that ruling.  The Company continues to evaluate its legal options with respect to this decision.  Depending upon the outcome of all of the legal proceedings, including the planned transaction below, which would resolve this litigation, the Company may be required to refund a portion of the initial valuation payment, or may receive additional proceeds.  The Northern Assets relinquished represent approximately 0.4% of the Company’s total assets. 

 

In addition, in December 2012, the Fort Wayne City Council considered an ordinance that sought to declare it a “public convenience and necessity” to acquire certain of the Company's water utility system assets located in the southwest section of the City and in Allen County (the “Southern Assets”), and if negotiations with Fort Wayne officials were to fail, to condemn the Southern Assets.  The first public hearing on the ordinance was held on January 22, 2013 and a subsequent hearing scheduled for February 5, 2013 was not held due to ongoing settlement discussions between the parties.  On July 2, 2013, the Company’s operating subsidiary and the City signed a letter of intent, which among other items, addresses many of the terms by which the City would purchase the Company’s Southern Assets, will resolve the litigation between the Company and the City with respect to the Northern Assets, and will establish the terms by which the Company’s operating

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subsidiary will treat wastewater sent to it by the City.  The letter of intent states that the City agrees to pay the Company $50,100 for the Northern Assets and Southern Assets in addition to the $16,911 paid to the Company by the City in 2008 as an initial valuation payment for the Northern Assets (for a total payment of $67,011).  The letter of intent is conditioned on the Company’s Board of Directors and City Council approving the final terms of the possible transaction, and the Company and the City entering into several definitive agreements that cover the subject matter of the letter of intent.  On February 27, 2014, the Company’s Board of Directors authorized management to enter into agreements with the City on terms and conditions that are consistent with the July 2, 2013 letter of intent, for among other items, the sale of the Company’s Northern Assets and Southern Assets to the City.  Further, the completion of the transaction is subject to regulatory requirements and approval.  The planned sale of these operations is accounted for as businesses held for sale beginning in the first quarter of 2014.  If this transaction is consummated, the Company will expand its sewer customer base by accepting new wastewater from the City.  The completion of the transaction is not expected to close until the fourth quarter of 2014.  The Company continues to evaluate its legal and operational options on an ongoing basis.

 

The operating results, cash flows, and financial position of the Company’s operations named above, during the periods owned, have been presented in the Company’s consolidated statements of net income, consolidated statements of cash flow, and consolidated balance sheets as discontinued operations.  These operations were included in the Company’s “Regulated” segment.     

 

A summary of discontinued operations presented in the consolidated statements of net income include the following:

 

 

 

 

 

 

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The assets and liabilities of discontinued operations presented in the consolidated balance sheets include the following:

 

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Note 5             Capitalization

 

In May 2013, the Board of Directors of the Company approved a five-for-four stock split to be effected in the form of a 25% stock distribution to shareholders of record on August 16, 2013.  Common shares outstanding do not include shares held by the Company in treasury.  The new shares were distributed on September 1, 2013.  Aqua America’s par value of $0.50 per share did not change as a result of the common stock distribution, and $17,655 was transferred from capital in excess of par value to common stock to record the stock split.  All common share, per common share, stock unit, and per stock unit data, for all periods presented, has been adjusted to give effect to the stock split.   

 

Note 6             Fair Value of Financial Instruments 

 

The Company follows the Financial Accounting Standards Board’s (“FASB”) accounting guidance for fair value measurements and disclosures, which defines fair value and establishes a framework for using fair value to measure assets and liabilities.  That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques

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used to measure fair value.  The hierarchy gives highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).  The three levels of the fair value hierarchy are as follows: 

 

 

 

 

The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.  Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.  There have been no changes in the valuation techniques used to measure fair value or asset or liability transfers between the levels of the fair value hierarchy for the quarter ended March 31, 2014. 

 

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

 

The fair value of funds restricted for construction activity and loans payable are determined based on their carrying amount and utilizing Level 1 methods and assumptions.  As of March 31, 2014 and December 31, 2013, the carrying amount of the Company’s funds restricted for construction activity was $47 and $47,  respectively, which equates to their estimated fair value.  As of March 31, 2014 and December 31, 2013, the carrying amount of the Company’s loans payable was $27,913 and $36,740, respectively, which equates to their estimated fair value.  The fair value of cash and cash equivalents, which is comprised of a money market fund, is determined based on the net asset value per unit utilizing Level 2 methods and assumptions.  As of March 31, 2014 and December 31, 2013, the carrying amounts of the Company's cash and cash equivalents was $17,508 and $5,058,  respectively, which equates to their fair value.   

 

 

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

 

 

The fair value of long-term debt has been determined by discounting the future cash flows using current market interest rates for similar financial instruments of the same duration utilizing Level 2 methods and assumptions.  The Company’s customers’ advances for construction have a carrying value of $73,728 as of March 31, 2014, and $73,892 as of December 31, 2013.   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 2029 and amounts not paid by the respective contract expiration dates become non-refundable.  The fair value of these amounts would, however, be less than their carrying value due to the non-interest bearing feature.

 

 

Note 7             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: 

 

 

For the three months ended March 31, 2014, all of the Company’s employee stock options were included in the calculations of diluted net income per share as the calculated cost to

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exercise the stock options was less than the average market price of the Company’s common stock during these periods.  For the three months ended March 31, 2013, employee stock options to purchase 494,156 shares of common stock, were excluded from the calculations of diluted net income per share as the calculated cost to exercise the stock options was greater than the average market price of the Company’s common stock during these periods. 

 

 

 

 

 

 

Note 8              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 6,250,000 shares for issuance under the plan.  A maximum of 50% of the shares available for issuance under the 2009 Plan may be issued pursuant to stock awards, stock units and other stock-based awards and the maximum number of shares that may be subject to grants under the 2009 Plan to any one individual in any one year is 250,000.  Awards under the 2009 Plan are made by a committee of the Board of Directors.  At March 31, 2014, 4,483,011 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.   

 

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 respective vesting period, generally three years.  Each grantee is granted a target award of PSUs, and may earn between 0% and 200% of the target amount depending on the Company’s performance against the performance goals.  The following table provides compensation costs for stock-based compensation related to performance share units: 

 

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The following table summarizes nonvested PSU transactions for the three months ended March 31, 2014:   

 

 

 

 

A portion of the fair value of PSUs was estimated at the grant date based on the probability of satisfying the market-based conditions associated with the PSUs using the Monte Carlo valuation method.  The other portion of the fair value of the PSUs is based on the fair market value of the Company’s stock at the grant date, regardless of whether the market-based condition is satisfied.  The per unit weighted-average fair value at the date of grant for PSUs granted during the three months ended March 31, 2014 and 2013 was $25.31 and $26.88, respectively.  The fair value of each PSU grant is amortized monthly into compensation expense on a straight-line basis over their respective vesting periods, generally 36 months.  The accrual of compensation costs is based on our estimate of the final expected value of the award, and is adjusted as required for the portion based on the performance-based condition.  The Company assumes that forfeitures will be minimal, and recognizes forfeitures as they occur, which results in a reduction in compensation expense.  As the payout of the PSUs includes dividend equivalents, no dividend yield assumption is required in calculating the fair value of the PSUs.  The recording of compensation expense for PSUs has no impact on net cash flows.   

 

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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.  In some cases the right to receive the shares is subject to certain performance goals established at the time the grant is made.  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 provides compensation costs for stock-based compensation related to restricted stock units:

 

 

The following table summarizes nonvested RSU transactions for the three months ended March 31, 2014: 

 

 

The per unit weighted-average fair value at the date of grant for RSUs granted during the three months ended March 31, 2014 and 2013 was $24.80 and $23.28, respectively.   

 

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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:

There were no stock options granted during the three months ended March 31, 2014 or 2013. 

 

The following table summarizes stock option transactions for the three months ended March 31, 2014:

 

 

Restricted Stock – The following table provides compensation costs for stock-based compensation related to restricted stock:

 

 

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The following table summarizes nonvested restricted stock transactions for the three months ended March 31, 2014:

There was no restricted stock granted during the three months ended March 31, 2014 or 2013.

  

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Note 9             Pension Plans and Other Postretirement Benefits  

 

The Company maintains a qualified defined benefit pension plan (the “Pension Plan”), a nonqualified pension plan 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 cost:

 

The Company made cash contributions of $8,937 to its Pension Plan during the first three months of 2014, and intends to make cash contributions of $8,937 to the Pension Plan during the remainder of 2014.  In addition, the Company expects to make cash contributions of $2,763, to the extent allowable for a tax deduction, for the funding of its other postretirement benefit plans during the remainder of 2014.

 

In the first quarter of 2014 the Company offered a one-time voluntary lump sum window to certain eligible terminated vested participants in an effort to reduce its long-term obligations and plan volatility for its Pension Plan.  In May 2014, the Pension Plan paid $11,417 to participants who elected to receive a lump sum distribution, which was funded from the existing Pension Plan assets.  

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Note 10           Water and Wastewater Rates 

 

During the first three months of 2014, the Company’s operating divisions in Ohio, Texas, New Jersey, Virginia, and Indiana were granted base rate increases designed to increase total operating revenues on an annual basis by $2,715.  Further, during the first three months of 2014, the Company’s operating divisions in Illinois and New Jersey received infrastructure rehabilitation surcharges designed to increase total operating revenues on an annual basis by $1,429.

 

In May 2014, the North Carolina Utilities Commission granted the Company’s operating subsidiary in North Carolina a water and wastewater rate increase designed to increase total operating revenue by $2,471, on an annual basis.

 

Note 11            Taxes Other than Income Taxes 

 

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

 

 

 

   

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Note 12           Segment Information 

 

The Company has identified ten operating segments and has one reportable segment named the “Regulated” segment.  The reportable segment is comprised of eight 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, two segments are not quantitatively significant to be reportable and are comprised of the Company’s non-regulated subsidiaries:  Aqua Resources, Inc. and Aqua Infrastructure LLC.  Aqua Resources, Inc. provides water and wastewater services through operating and maintenance contracts with municipal authorities and other parties in close proximity to our utility companies’ service territories as well as offers, through a third party, water and sewer line repair service and protection solutions to households, liquid waste hauling and disposal, backflow prevention, construction, and other non-regulated water and wastewater services.  Aqua Infrastructure LLC provides non-utility raw water supply services for firms, with which the Company enters into water supply contracts, in the natural gas drilling industry.  These two segments are 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.  Corporate costs include general and administrative expense, and interest expense. 

 

The following table presents information about the Company’s reportable segment:

 

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Note 13            Commitments and Contingencies 

 

The Company is routinely involved in various disputes, claims, lawsuits and other regulatory and legal matters, including both asserted and unasserted legal claims, in the ordinary course of business.  The status of each such matter, referred to herein as a loss contingency, is reviewed and assessed in accordance with applicable accounting rules regarding the nature of the matter, the likelihood that a loss will be incurred, and the amounts involved.  As of March 31, 2014, the aggregate amount of $11,835 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 March 31, 2014, estimates that approximately $1,388 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.

 

In addition to the aforementioned loss contingencies, the Company self-insures its employee medical benefit program, and maintains stop-loss coverage to limit the exposure arising from these claims.  The Company’s reserve for these claims totaled $1,965 at March 31, 2014 and represents a reserve for unpaid claim costs, including an estimate for the cost of incurred but not reported claims.  

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Note 14           Income Taxes 

 

During the three months ended March 31, 2014, the Company utilized $15,422 of its Federal net operating loss carryforward (“NOL”).  In addition, during the three months ended March 31, 2014, the Company’s state NOL carryforward increased by $2,789.  As of March 31, 2014, the balance of the Company’s Federal NOL was $242,671.  The Company believes its Federal NOL carryforward is more likely than not to be recovered and requires no valuation allowance.  As of March 31, 2014, the balance of the Company’s state NOL was $533,949, a portion of which was offset by a valuation allowance of $5,229 because the Company does not believe the NOLs are more likely than not to be realized.  The Company’s Federal and state NOL carryforwards begin to expire 2031 and 2023, respectively.   The Company has unrecognized tax positions that result in the associated tax benefit being unrecognized.  The Company’s Federal and state NOL carryforwards are reduced by an unrecognized tax position, on a gross basis, of $62,865 and $86,016, respectively, which results from the Company’s adoption in the third quarter of 2013 of the FASB’s accounting guidance on the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists.  The amounts of the Company’s Federal and state NOL carryforwards prior to being reduced by the unrecognized tax positions were $305,536 and $619,965, respectively.  The Company records its unrecognized tax benefit as a reduction to its deferred income tax liability. 

 

In December 2012, the Company changed its tax method of accounting for qualifying utility system repairs in Aqua Pennsylvania, Inc. (“Aqua Pennsylvania”) effective with the tax year ended December 31, 2012 and for prior tax years.  The tax accounting method was changed to permit the expensing of qualifying utility asset improvement costs that were previously being capitalized and depreciated for book and tax purposes (the “Repair Change”).  As a result of the adoption of the Repair Change prior to the receipt of Aqua Pennsylvania’s next rate order, the Repair Change results in a substantial reduction in income tax expense and greater net income and cash flows.  The Company’s effective income tax rate for the first quarter of 2014 and 2013, for its continuing operations, was 10.9% and 14.2%, respectively. 

 

In September 2013, the Department of Treasury and the Internal Revenue Service issued “Guidance Regarding and Capitalization of Expenditures Related to Tangible Property” which contains standards for determining whether and when a taxpayer must capitalize costs incurred in acquiring, maintaining or improving tangible property.  These regulations are effective for the Company’s 2014 fiscal year.  The Company has reviewed the regulations and concluded that the regulations will not have a material impact on the Company’s consolidated results of operations or consolidated financial position.

 

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As of March 31, 2014, the total gross unrecognized tax benefit was $28,850, of which $10,534, if recognized, would affect the Company’s effective tax rate as a result of the regulatory treatment afforded the Repair Change in Pennsylvania.  At December 31, 2013, the Company had unrecognized tax benefits of $28,690.  There was no unrecognized tax benefit at March 31, 2013 or December 31, 2012.

 

Accounting rules for uncertain tax positions specify that tax positions for which the timing of resolution is uncertain should be classified as long-term liabilities.  Judgment is required in evaluating the Company’s uncertain tax positions and determining the provision for income taxes.  Management believes that an adequate provision has been made for any adjustments that may result from tax examinations.  Although the timing of income tax audit resolutions and negotiations with taxing authorities is highly uncertain, the Company does not anticipate a significant change to the total amount of unrecognized income tax benefits within the next 12 months.

 

Note 15            Recent Accounting Pronouncements   

 

In April 2014, the FASB issued updated accounting guidance which changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements.  The updated guidance is effective prospectively for reporting periods beginning after December 15, 2014, with early adoption available.  The Company will adopt the provisions of the updated accounting guidance for its quarterly reporting period beginning January 1, 2015, and the Company does not expect the adoption of the revised guidance to have an impact on the Company’s consolidated results of operations or consolidated financial position.