1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 8-K CURRENT REPORT Pursuant To Section 13 or 15(d) of The Securities Exchange Act of 1934 Date of Report (Date of earliest event reported): January 29, 1998 PHILADELPHIA SUBURBAN CORPORATION (Exact name of registrant as specified in its charter) Pennsylvania 1-6659 23-1702594 (State or other (Commission (IRS Employer jurisdiction of File Number) Identification Number) incorporation) 762 Lancaster Avenue, Bryn Mawr, Pennsylvania 19010 (Address of principal executive offices) (Zip Code) (610) 527-8000 (Registrant's telephone number, including area code) Not Applicable (Former name or former address, if changed since last report.) 2 Item 5. Other Events. The Registrant hereby files herewith: (i) its audited consolidated balance sheets and statements of capitalization of Registrant and its subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income and cash flow for each of the years in the three-year period ended December 31, 1997 as Exhibit 99.1 hereto; (ii) its Management's Discussion and Analysis of Financial Condition and Results of Operations related to its fiscal year ended December 31, 1997 as Exhibit 99.2 hereto; and (iii) its Summary of Selected Financial Data for Registrant and its subsidiaries for each of the years in the five-year period ended December 31, 1997 as Exhibit 99.3 hereto. 2 3 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PHILADELPHIA SUBURBAN CORPORATION Date: January 29, 1998 /s/ Roy H. Stahl ------------------------------------------- Name: Roy H. Stahl Title: Senior Vice President and General Counsel 3 4 EXHIBIT INDEX Exhibit Page - ------- ---- 99.1 Registrant's audited consolidated 5 balance sheets and statements of capitalization of Registrant and its subsidiaries as of December 31, 1997 and 1996, and related consolidated statements of income and cash flow for each of the years in the three-year period ended December 31, 1997. 99.2 Registrant's Management's 32 Discussion and Analysis of Financial Condition and Results of Operations related to its fiscal year ended December 31, 1997. 99.3 Registrant's Summary of Selected 44 Financial Data for Registrant and its subsidiaries for each of the years in the five-year period ended December 31, 1997 4 5 EXHIBIT 99.1 MANAGEMENT'S REPORT The consolidated financial statements and related information for the years ended December 31, 1997, 1996 and 1995 were prepared by management in accordance with generally accepted accounting principles and include management's best estimates and judgments, as required. Financial information included in other sections of this annual report is consistent with that in the consolidated financial statements. The Company has an internal accounting control structure designed to provide reasonable assurance that assets are safeguarded and that transactions are properly authorized and recorded in accordance with established policies and procedures. The internal control structure is supported by the selection and training of qualified personnel, the delegation of management authority and responsibility and dissemination of policies and procedures. The Company's independent auditors, KPMG Peat Marwick LLP, provide an independent review of management's reporting of results of operations and financial condition. KPMG has audited the financial statements by conducting tests as they deemed appropriate and their report follows. The Board of Directors through the Audit Committee selects the Company's independent auditors and reviews the scope and results of their audits. The Audit Committee also reviews the adequacy of the Company's internal control structure and other significant matters. The Audit Committee is comprised of four outside Directors who meet periodically with management and the independent auditors. The Audit Committee held two meetings in 1997. /s/ Nicholas DeBenedictis /s/ Michael P. Graham Nicholas DeBenedictis Michael P. Graham Chairman & Senior Vice President - Finance President & Treasurer 5 6 INDEPENDENT AUDITORS' REPORT The Stockholders and Board of Directors Philadelphia Suburban Corporation: We have audited the accompanying consolidated balance sheets and statements of capitalization of Philadelphia Suburban Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, and cash flow for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Philadelphia Suburban Corporation and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ KPMG PEAT MARWICK LLP KPMG PEAT MARWICK LLP Philadelphia, Pennsylvania January 28, 1998 6 7 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands of dollars, except per share amounts) December 31, 1997 and 1996 See accompanying notes to consolidated financial statements 7
1997 1996 ------------------------ Assets Property, plant and equipment, at cost $ 656,011 $ 612,812 Less accumulated depreciation 121,528 109,874 ------------------------ Net property, plant and equipment 534,483 502,938 ------------------------ Current assets: Cash 680 1,518 Accounts receivable, net 23,534 21,914 Inventory, materials and supplies 1,847 1,943 Prepayments and other current assets 1,002 660 ------------------------ Total current assets 27,063 26,035 ------------------------ Regulatory assets 51,203 48,491 Deferred charges and other assets, net 5,723 5,480 ------------------------ $ 618,472 $ 582,944 ======================== Liabilities and Stockholders' Equity Stockholders' equity: 6.05% Series B cumulative preferred stock $ 3,220 $ 3,220 Common stock at $.50 par value, authorized 40,000,000 shares, outstanding 26,210,654 and 25,598,105 in 1997 and 1996 13,294 9,731 Capital in excess of par value 128,065 121,439 Retained earnings 56,136 49,272 Treasury stock, 376,510 and 262,230 shares in 1997 and 1996 (5,970) (3,647) ------------------------ Total stockholders' equity 194,745 180,015 ------------------------ Preferred stock of subsidiary with mandatory redemption requirements -- 4,214 Long-term debt, excluding current portion 232,471 217,518 Commitments -- -- Current liabilities: Current portion of long-term debt and preferred stock of subsidiary 6,662 13,873 Loans payable 10,400 5,560 Accounts payable 10,259 9,659 Accrued interest 3,978 3,660 Accrued taxes 3,643 3,363 Other accrued liabilities 9,755 8,924 ------------------------ Total current liabilities 44,697 45,039 ------------------------ Deferred credits and other liabilities: Deferred income taxes and investment tax credits 83,129 75,949 Customers' advances for construction 25,810 23,524 Other 12,764 12,826 ------------------------ Total deferred credits and other liabilities 121,703 112,299 ------------------------ Contributions in aid of construction 24,856 23,859 ------------------------ $ 618,472 $ 582,944 ======================== 8 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share amounts) Years ended December 31, 1997, 1996 and 1995 See accompanying notes to consolidated financial statements. 8
1997 1996 1995 --------------------------------------- Earned revenues $ 136,171 $ 122,503 $ 117,044 Costs and expenses: Operating expenses 55,899 51,615 51,702 Depreciation 14,311 13,068 11,572 Amortization 269 265 (15) Taxes other than income taxes 8,893 8,265 7,676 --------------------------------------- 79,372 73,213 70,935 Operating income 56,799 49,290 46,109 Interest expense 17,890 15,311 14,852 Dividends on preferred stock of subsidiary 370 494 631 Allowance for funds used during construction (522) (264) (305) --------------------------------------- Income from continuing operations before income taxes 39,061 33,749 30,931 Provision for income taxes 15,873 13,971 12,901 --------------------------------------- Income from continuing operations 23,188 19,778 18,030 Reversal of reserve for discontinued operations, net of income tax of $520 and $200, in 1996 and 1995 -- 965 370 --------------------------------------- Net income 23,188 20,743 18,400 Dividends on preferred stock 195 21 -- --------------------------------------- Net income available to common stock $ 22,993 $ 20,722 $ 18,400 ======================================= Basic net income per common share: Continuing operations $ 0.89 $ 0.79 $ 0.75 Discontinued operations -- 0.04 0.02 --------------------------------------- Total $ 0.89 $ 0.83 $ 0.77 ======================================= Diluted net income per common share: Continuing operations $ 0.88 $ 0.78 $ 0.75 Discontinued operations -- 0.04 0.02 --------------------------------------- Total $ 0.88 $ 0.82 $ 0.77 ======================================= Average common shares outstanding during the period 25,908 24,966 23,803 ======================================= 9 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES CONSOLIDATED CASH FLOW STATEMENTS (In thousands of dollars) Years ended December 31, 1997, 1996 and 1995 See Acquisitions footnote for description of non-cash investing and financing activities. See accompanying notes to consolidated financial statements. 9
1997 1996 1995 ------------------------------------ Cash flows from operating activities: Income from continuing operations $ 23,188 $ 19,778 $ 18,030 Adjustments to reconcile income from continuing operations to net cash flows from operating activities: Depreciation and amortization 14,580 13,333 11,557 Deferred taxes, net of taxes on customers' advances 3,797 2,628 2,573 Net increase in receivables, inventory and prepayments (1,396) (517) (2,037) Net increase in payables, accrued interest and other accrued liabilities 2,354 1,748 4,604 Other (680) 452 (1,773) ------------------------------------ Net cash flows from operating activities 41,843 37,422 32,954 ------------------------------------ Cash flows from investing activities: Property, plant and equipment additions, including allowance for funds used during construction of $522, $264 and $305 (38,960) (31,389) (33,182) Acquisitions of water and wastewater systems (1,226) (42,122) (26,351) Other (535) 24 (91) ------------------------------------ Net cash flows used in investing activities (40,721) (73,487) (59,624) ------------------------------------ Cash flows from financing activities: Customers' advances and contributions in aid of construction 953 470 1,600 Repayments of customers' advances (2,408) (2,142) (2,104) Net proceeds (repayments) of short-term debt 4,840 (895) 2,405 Proceeds from long-term debt 29,665 64,256 57,906 Repayments of long-term debt including premium on early retirement (25,042) (24,094) (23,585) Redemption of preferred stock of subsidiary (1,428) (1,500) (2,857) Proceeds from issuing common stock 10,695 14,651 9,060 Repurchase of common stock (2,829) (760) (733) Dividends paid on preferred stock (195) (4) -- Dividends paid on common stock (16,129) (14,795) (13,546) Other (82) (167) (154) ------------------------------------ Net cash flows from (used in) financing activities (1,960) 35,020 27,992 ------------------------------------ Net cash flows from (used in) discontinued operations -- 176 (178) ------------------------------------ Net increase (decrease) in cash (838) (869) 1,144 Cash balance beginning of year 1,518 2,387 1,243 ------------------------------------ Cash balance end of year $ 680 $ 1,518 $ 2,387 ==================================== 10 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CAPITALIZATION (In thousands of dollars, except per share amounts) December 31, 1997 and 1996 *Trust indentures relating to these First Mortgage Bonds require annual sinking fund payments. See accompanying notes to consolidated financial statements. 10
1997 1996 ------------------------ Stockholders' equity: 6.05% Series B cumulative preferred stock $ 3,220 $ 3,220 Common stock, $.50 par value 13,294 9,731 Capital in excess of par value 128,065 121,439 Retained earnings 56,136 49,272 Treasury stock (5,970) (3,647) ------------------------ Total stockholders' equity 194,745 180,015 ------------------------ Preferred stock of subsidiary with mandatory redemption requirements 4,214 5,643 Current portion of preferred stock of subsidiary 4,214 1,429 ------------------------ -- 4,214 ------------------------ Long-term debt: First Mortgage Bonds secured by utility plant: 8.44% Series, due 1997 -- 12,000 5.95% Series, due 2002* 2,000 2,400 6.30% Series, due 2002 10,000 -- 6.83% Series, due 2003 10,000 10,000 7.47% Series, due 2003 10,000 10,000 7.06% Series, due 2004 10,000 -- 6.82% Series, due 2005 10,000 10,000 6.99% Series, due 2006 10,000 10,000 6.75% Series, due 2007 10,000 -- 9.89% Series, due 2008 5,000 5,000 7.15% Series, due 2008* 22,000 22,000 9.12% Series, due 2010 20,000 20,000 6.50% Series, due 2010* 3,200 3,200 9.17% Series, due 2011 5,000 5,000 9.93% Series, due 2013 5,000 5,000 6.89% Series, due 2015 12,000 12,000 9.97% Series, due 2018 5,000 5,000 9.17% Series, due 2021* 8,000 8,000 6.35% Series, due 2025 22,000 22,000 7.72% Series, due 2025 15,000 15,000 9.29% Series, due 2026 12,000 12,000 ------------------------ Total First Mortgage Bonds 206,200 188,600 Note payable to bank under revolving credit agreement, due March 1998 27,128 39,727 Installment note payable, 9%, due in equal annual payments through 2013 1,591 1,635 ------------------------ 234,919 229,962 Current portion of long-term debt 2,448 12,444 ------------------------ Long-term debt, excluding current portion 232,471 217,518 ------------------------ Total capitalization $ 427,216 $ 401,747 ======================== 11 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) Summary of Significant Accounting Policies Nature of Operations The business of Philadelphia Suburban Corporation (the "Company") is conducted primarily through its subsidiary Philadelphia Suburban Water Company ("PSW"). PSW is a regulated public utility which supplies water to approximately 288,000 customers. The customers are residential, commercial and industrial in nature, and no single customer accounted for more than one percent of PSW's sales. The service territory of PSW covers a 464 square mile area located west and north of the City of Philadelphia. In addition, PSW provides water service to approximately 6,000 customers through an operating and maintenance contract with a municipal authority contiguous to its service territory. PSW is subject to regulation by the Pennsylvania Public Utility Commission ("PUC") which has jurisdiction with respect to rates, service, accounting procedures, issuance of securities, acquisitions and other matters. Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All material intercompany accounts and transactions have been eliminated. Recognition of Revenues Revenues include amounts billed to customers on a cycle basis and unbilled amounts based on estimated usage from the latest billing to the end of the accounting period. Non-utility revenues are recognized when services are performed. Net Income per Common Share The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" in the fourth quarter of 1997. SFAS No. 128 requires the Company to use methods for calculating earnings per share that differ from methods used in prior periods and requires the Company to restate net income per share reported in prior periods. The adoption of this statement had no effect on the results of operations, financial conditions, or long-term liquidity. Property, Plant and Equipment and Depreciation Property, plant and equipment consist primarily of utility plant. The cost of additions includes contracted cost, direct labor and fringe benefits, materials, overheads and, for certain utility plant, allowance for funds used during construction. Water systems acquired are recorded at estimated original cost of utility plant when first devoted to utility service and the applicable depreciation is recorded to accumulated depreciation. The difference between the estimated original cost, less applicable depreciation, and the purchase price is recorded as an acquisition adjustment within utility plant. At December 31, 1997, utility plant includes a credit acquisition adjustment of $6,719, which is being amortized over 20 years. Consistent with PSW's rate settlements, $449 was amortized during 1997, $526 was amortized during 1996 and $529 was amortized during 1995. 11 12 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) Utility expenditures for maintenance and repairs, including minor renewals and betterments, are charged to operating expenses in accordance with the Uniform System of Accounts prescribed by the PUC. The cost of new units of property and betterments are capitalized. When units of utility property are replaced, retired or abandoned, the recorded value thereof is credited to the asset account and such value, together with the net cost of removal, is charged to accumulated depreciation. The straight-line remaining life method is used to compute depreciation on utility plant. The straight-line method is used with respect to transportation and mechanical equipment, office equipment and laboratory equipment. In accordance with the requirements of SFAS No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of", the long-lived assets of the Company, which consist primarily of Utility Plant in Service and a regulatory asset, have been reviewed for impairment. There has been no change in circumstances or events that have occurred that require adjustments to the carrying values of these assets. Allowance for Funds Used During Construction The allowance for funds used during construction ("AFUDC") is a non-cash credit which represents the estimated cost of funds used to finance the construction of utility plant. AFUDC is applied to construction projects requiring more than one month to complete. No AFUDC is applied to projects funded by customer advances for construction or contributions in aid of construction. AFUDC includes the net cost of borrowed funds and a rate of return on other funds when used, and is recovered through water rates as the utility plant is depreciated. There was no AFUDC related to equity funds in any of the years presented. Deferred Charges and Other Assets Deferred bond and preferred stock issuance expenses are amortized by the straight-line method over the life of the related issues. Call premiums related to the early redemption of long-term debt, along with the unamortized balance of the related issuance expense, are deferred and amortized over the life of the long-term debt used to fund the redemption. Expenses associated with filing for rate increases are deferred and amortized over approximately 18 months. Other costs, for which PSW has received or expects to receive prospective rate recovery, are deferred and amortized over the period of rate recovery. Income Taxes The Company accounts for certain income and expense items in different time periods for financial reporting than for tax reporting purposes. Deferred income taxes are provided on the temporary differences between the tax basis of the assets and liabilities and the amounts at which they are carried in the financial statements. These deferred income taxes are based on the enacted tax rates expected to be in effect when 12 13 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) such temporary differences are projected to reverse. Customers' Advances for Construction Water mains or, in some instances, cash advances to reimburse PSW its costs to construct water mains, are contributed to PSW by customers, real estate developers and builders in order to extend water service to their properties. The value of these contributions is recorded as Customers' Advances for Construction. PSW makes refunds on these advances over a specific period of time based on operating revenues related to the main or as new customers are connected to and take service from the main. After all refunds are made, any remaining balance is transferred to Contributions in Aid of Construction. Contributions in Aid of Construction Contributions in aid of construction include direct non-refundable contributions and the portion of customers' advances for construction that become non-refundable. Inventories, Materials and Supplies Inventories are stated at cost, not in excess of market value. Cost is determined using the first-in, first-out method. Stock-Based Compensation In 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation", electing the provision of the statement allowing it to continue its practice of not recognizing compensation expense related to granting of stock options to the extent that the option price of the underlying stock was equal to, or greater than, the market price on the date of option grant. Disclosure of the impact on the results of operations, had the Company elected to recognize compensation expense, is provided in the Employee Stock and Incentive Plans footnote as required by the Statement. Use of Estimates in Preparation of Consolidated Financial Statements The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain prior year amounts have been reclassified to conform with current year's presentation. Acquisitions During 1997, PSW made the following acquisitions: in January, the franchise rights and the 13 14 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) water utility assets of Cherry Water Company; in September, the franchise rights and water utility assets of Perkiomen Township and in September, the franchise rights and both the water and wastewater utility assets of the Peddler's View Utility Company. The systems acquired in 1997 incorporate two square miles of service area near PSW's existing territory. The total purchase price for the three water systems and wastewater system acquired in 1997 was $1,226. The annual revenues from these systems approximate $300, and revenues included in the consolidated financial statements during the period owned by PSW were $175. During 1996, PSW made the following acquisitions: in October the franchise rights and the water utility assets of Hatboro Borough Authority; in November, Utility Group Services Corporation ("UGS") which owned three water utilities and a wastewater utility; in December, the franchise rights and the water utility assets of Bristol Borough Water and Sewer Authority and at various times during 1996 the franchise rights and the water utility assets of three smaller water systems. The total purchase price for the eight water systems and wastewater system acquired in 1996 was $47,889, including the issuance of $3,220 of the Company's preferred stock and the assumption of $2,547 in liabilities. These systems have a combined service territory of 64 square miles. Revenues included in the consolidated financial statements related to the systems acquired in 1996 were $5,902 in 1997 and $466 in 1996. In May 1995, PSW purchased the franchise rights and the water utility assets of Media Borough ("Media"). The Media system covers a 23 square mile service area contiguous to PSW's service territory. In addition, PSW purchased the franchise rights and the water utility assets of four smaller water systems in 1995 that cover a combined service territory of four square miles. PSW paid $26,351 for the water systems acquired in 1995. These systems serve customers within or contiguous to the boundaries of PSW's existing service territory. Revenues included in the consolidated financial statements related to the water supply systems acquired in 1995 were $4,954 in 1997, $4,470 in 1996 and $2,820 in 1995. In addition, in January 1998, PSW purchased the franchise rights and the water utility assets of West Chester Area Municipal Authority ("West Chester") for $22,400 in cash, subject to minor adjustment related to the final value of current assets transferred and recent capital expenditures. The West Chester service territory covers 16 square miles and is contiguous to PSW's territory. The annual revenues of the West Chester system approximate $4,500. PSW has also entered into a letter of intent to acquire the Flying Hills Water Company ("Flying Hills") in a purchase transaction for approximately 45,000 shares of the Company's Common Stock. This transaction, which is subject to final negotiation and the approval of the PUC, is expected to be completed in the first quarter of 1998. The Flying Hills system covers a one square mile area in Berks County near Reading, Pennsylvania and is 16 miles from the nearest edge of PSW's system. The annual revenues of the Flying Hills system approximate $200. 14 15 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) Income Taxes Total income tax expense is allocated as follows: Income tax expense attributable to income from continuing operations consists of:
Years Ended December 31, ---------------------------------------------- 1997 1996 1995 ---------------------------------------------- Income from continuing operations $ 15,873 $ 13,971 $ 12,901 Common stockholders' equity related to stock option activity which reduces taxable income (401) (126) (44) Discontinued operations -- 520 200 ---------------------------------------------- $ 15,472 $ 14,365 $ 13,057 ============================================== 15
Years Ended December 31, ------------------------------------------------ 1997 1996 1995 ------------------------------------------------ Current: Federal $ 8,742 $ 8,084 $ 7,688 State 2,800 2,600 2,514 ------------------------------------------------ 11,542 10,684 10,202 ------------------------------------------------ Deferred: Federal 4,004 3,002 2,565 State 327 285 134 ------------------------------------------------ 4,331 3,287 2,699 ------------------------------------------------ Total tax expense $ 15,873 $ 13,971 $12,901 ================================================ 16 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) The significant components of deferred income tax expense are as follows: The statutory Federal tax rate is 35% and the Pennsylvania Corporate Net Income Tax rate is 9.99% for all years presented. The reasons for the differences between amounts computed by applying the statutory Federal income tax rate to income from continuing operations before Federal tax and the actual Federal tax expense are as follows: 16
Years Ended December 31, ---------------------------------------- 1997 1996 1995 ---------------------------------------- Excess of tax over financial statement depreciation $ 3,308 $ 2,458 $ 2,323 Amortization of deferred investment tax credits (105) (115) (151) Current year investment tax credits deferred 35 40 90 Differences in basis of fixed assets due to variations in tax and book accounting methods that reverse through depreciation 860 770 819 Customers' advances for construction, net 556 196 (443) Other, net (323) (62) 61 ---------------------------------------- Total deferred income tax expense $ 4,331 $ 3,287 $ 2,699 ======================================== 17 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) The tax effects of temporary differences between book and tax accounting that give rise to the deferred tax assets and deferred tax liabilities are as follows:
Years Ended December 31, ------------------------------------------- 1997 1996 1995 ------------------------------------------- Computed Federal tax expense at statutory rate $ 12,508 $ 10,795 $ 9,899 Increase (decrease) in tax expense for items to be recovered in future rates: Depreciation expense 70 179 132 Losses on asset disposals (2) (12) (35) Amortization of deferred investment tax credits (105) (115) (151) Preferred stock dividend 197 180 221 Other, net 78 59 187 ------------------------------------------- Actual Federal tax expense $ 12,746 $ 11,086 $ 10,253 =========================================== The Company made income tax payments, which include amounts related to discontinued operations, of $11,346, $10,199 and $9,730 in 1997, 1996 and 1995, respectively. The Company's Federal income tax returns for all years through 1993 have been closed. 17
December 31, ---------------------- 1997 1996 ---------------------- Deferred tax assets: Customers' advances for construction $ 9,198 $ 9,753 Costs expensed for book not deducted for tax, principally accrued expenses and bad debt reserves 2,393 2,638 Other 642 389 ---------------------- Total gross deferred tax assets 12,233 12,780 ---------------------- Deferred tax liabilities: Utility plant, principally due to depreciation and differences in the basis of fixed assets due to variation in tax and book accounting 71,888 65,666 Deferred taxes associated with the gross-up of revenues necessary to recover, in rates, the effect of temporary differences 18,937 17,801 Deferred investment tax credit 4,218 4,288 Other 319 974 ---------------------- Total gross deferred tax liabilities 95,362 88,729 ---------------------- Net deferred tax liability $83,129 $75,949 ====================== 18 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) Property, Plant and Equipment Depreciation is computed based on estimated useful lives of 5 to 110 years for utility plant and 3 to 10 years for both utility transportation and mechanical equipment and all non-utility plant and equipment. Accounts Receivable
December 31, ------------------------- 1997 1996 ------------------------- Utility plant and equipment $641,303 $604,298 Utility construction work in progress 12,426 6,232 Non-utility plant and equipment 2,282 2,282 ------------------------- Total property, plant and equipment $656,011 $612,812 ========================= All of the Company's customers are located in southeastern Pennsylvania. No single customer accounted for more than one percent of the Company's sales in 1997 or 1996 and no account receivable from any customer exceeded one percent of the Company's total stockholders' equity. Regulatory Asset The regulatory asset represents costs which have been prudently incurred and are expected to be fully recovered in future rates. The two components of this asset are deferred income taxes and postretirement benefits other than pensions. Items giving rise to deferred state income taxes, as well as a portion of deferred Federal income taxes related to certain differences between tax and book depreciation expense, are recognized in the rate setting process on a cash or flow through basis and will be recovered as they reverse. The portion of the asset related to postretirement benefits other than pensions represents costs that were deferred during the period that the accrual method of accounting for these benefits was adopted in 1993 and the recognition of the accrual method in the Company's rates in 1994. Amortization of the amount deferred for postretirement benefits other than pensions began in 1994 and is currently being recovered in rates. 18
December 31, ----------------------- 1997 1996 ----------------------- Billed water revenue $ 9,230 $ 9,760 Unbilled water revenue 13,949 11,764 Other 855 690 ----------------------- 24,034 22,214 Less allowance for doubtful accounts 500 300 ----------------------- Net accounts receivable $23,534 $21,914 ======================= 19 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) Commitments PSW maintains agreements with the Chester Water Authority and the Bucks County Water and Sewer Authority 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 2017. The estimated annual commitments related to such purchases total approximately $2,852 through 2002. PSW purchased approximately $2,978, $2,889 and $2,839 of water under these agreements during the years ended December 31, 1997, 1996 and 1995, respectively. PSW leases motor vehicles and other equipment under operating leases that are noncancelable and expire on various dates through 2002. During the next five years, $2,698 of future minimum lease payments are due: $1,026 in 1998, $834 in 1999, $504 in 2000, $315 in 2001 and $8 in 2002. PSW leases parcels of land on which its Media treatment plant and other facilities are situated and adjacent parcels that are used for watershed protection. The operating lease is noncancelable, expires in 2045 and contains certain renewal provisions. The lease is subject to an adjustment every five years based on changes in the Consumer Price Index. During each of the next five years, $292 of lease payments for land are due. Rent expense was $1,297, $1,332 and $1,067 for the years ended December 31, 1997, 1996 and 1995, respectively. Long-term Debt and Loans Payable The Consolidated Statements of Capitalization provides a listing of long-term debt and loans outstanding as of December 31, 1997 and 1996. The supplemental indentures with respect to certain issues of the First Mortgage Bonds restrict the ability of PSW to declare dividends, in cash or property, or repurchase or otherwise acquire PSW's stock. As of December 31, 1997, approximately $120,000 of retained earnings were free of these restrictions. Certain supplemental indentures also prohibit PSW from making loans to or purchasing the stock of the Company. Excluding amounts due under PSW's revolving credit agreement, the Company's sinking fund payments and debt maturities for the next five years are as follows:
December 31, ------------------------------------ 1997 1996 ------------------------------------ Income taxes $49,229 $46,381 Postretirement benefits other than pensions 1,974 2,110 ------------------------------------ $51,203 $48,491 ==================================== In July 1997, PSW established a two-year $150,000 medium-term note program providing for the issuance 19
1998 1999 2000 2001 2002 ---- ---- ---- ---- ---- Sinking fund payments $ 2,448 $ 2,452 $ 2,457 $ 2,462 $ 2,867 Maturities -- -- -- -- 10,000 --------------------------------------------------- Total $ 2,448 $2,452 $ 2,457 $ 2,462 $12,867 =================================================== 20 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) of long-term debt with maturities ranging between one and 35 years at fixed rates of interest, as determined at the time of issuance. This program replaced a similar program that expired in March 1997. The notes issued under this program are secured by the Thirty-First Supplement to the trust indenture relating to PSW's First Mortgage Bonds. During 1997, issuances through these programs were as follows: $10,000 in March 1997, 7.06% Series due 2004; $10,000 in July 1997, 6.75% Series due 2007; $10,000 in October 1997, 6.3% Series due 2002. During 1996, issuances through these programs were as follows: $10,000 in April 1996, 6.99% Series due 2006; $10,000 in July 1996, 7.47% Series due 2003; and $10,000 in November 1996, 6.83% Series due 2003. The proceeds from these issuances were used to fund acquisitions, the retirement of the First Mortgage Bonds noted below and for PSW's ongoing capital program. In January 1998, PSW issued $10,000 6.14% Series due 2008 and $10,000 5.8% Series due 2003 through the medium-term note program. Proceeds from these issues were used to reduce the balance of PSW's revolving credit facility. In January 1996, PSW retired $5,000 of First Mortgage Bonds, 7.875% Series due 1997, at a premium of .331% or $17 and $4,150 of First Mortgage Bonds, 8.4% Series due 2002, at a premium of 2.1% or $87. In April 1996, PSW retired $10,000 of First Mortgage Bonds, 10.65% Series due 2006, at a premium of 5.04% or $504. The unamortized bond issuance expenses related to the retirements in 1996 were $25. The premiums paid on the early retirement of debt, along with the related unamortized bond issuance expense, are capitalized and amortized, in accordance with the Uniform System of Accounts prescribed by the PUC, over the life of the long-term debt used to fund the redemption. In February 1994, PSW entered into a revolving credit agreement with four banks. In January 1998, PSW extended its revolving credit agreement, that was due to expire in March 1998, until January 2000 and increased the available borrowings under this facility from $30,000 to $50,000. Accordingly, amounts borrowed under this facility as of December 31, 1997 have been classified as long-term debt. The agreement was also amended in prior years to temporarily increase the available borrowings under this facility. Interest under this facility is based, at PSW's option, on the prime rate, an adjusted federal funds rate, an adjusted certificate of deposit rate corresponding to the interest period selected, an adjusted Euro-Rate corresponding to the interest period selected or at rates offered by the banks. This agreement restricts the total amount of short-term borrowings of PSW. A commitment fee of 1/8 of 1% is charged on the unused portion of the loan. The average cost of borrowing under this facility was 6.08% and 6.02%, and the average borrowing was $36,746 and $14,326, during 1997 and 1996, respectively. The maximum amount outstanding at the end of any one month was $48,743 in 1997 and $39,727 in 1996. At December 31, 1997 and 1996, the Company and PSW had combined short-term lines of credit of $16,000. Funds borrowed under these lines are classified as loans payable and are used to provide working capital. The average borrowing under the lines was $8,009 and $5,123 during 1997 and 1996, respectively. The maximum amount outstanding at the end of any one month was $11,090 in 1997 and $6,820 in 1996. Interest under the lines is based at the Company's option, depending on the line, on the prime rate, an adjusted Euro-Rate, an adjusted federal funds rate or at rates offered by the banks. The average cost of borrowings under all lines during 1997 and 1996 was 6.1%. The total amount of interest paid on all borrowings, net of amounts capitalized, was $17,616, 20 21 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) $15,503 and $14,923 in 1997, 1996 and 1995, respectively. The proforma weighted cost of long-term debt at December 31, 1997 and 1996 was 7.5% and 7.7%, respectively. Preferred Stock of Subsidiary with Mandatory Redemption Requirements PSW is authorized to issue up to 1,000,000 shares of preferred stock, with stated par value, in one or more series. In 1991, PSW issued 100,000 shares of 8.66% Series 1 Cumulative Preferred Stock, at par value of $100 per share in a private placement. Dividends on this issue are payable quarterly and are cumulative. PSW may not pay dividends on its common stock unless provision has been made for payment of the preferred dividends. As of December 31, 1997, all preferred dividends have been provided for. These shares are subject to mandatory annual redemption equal to the par value of 14,285 shares plus accrued dividends. In addition, PSW has exercised its right to call 14,285 shares per year starting in 1995, up to a maximum of 15,000 shares over the life of the issue, at par. The balance may be called, beginning in 1998, at a specified price above par. In December 1997, PSW provided notice to the holder of the preferred stock of its intention to call all the remaining shares in January 1998. As required by the share purchase agreement, 14,285 shares were redeemed at par value and a 4% premium or $111 was paid on the remaining 27,860 shares outstanding. Accordingly, $4,214 has been classified as the current portion of preferred stock as of December 31, 1997. 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 as of December 31, 1997 is $234,919 and $254,998, respectively. 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 carrying values of $25,810 and $6,092, respectively at December 31, 1997. Their relative fair values cannot be accurately estimated since 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 2018 and amounts not paid by the contract expiration dates become non-refundable. The fair value of these amounts would, however, be less than their carrying value due to the non-interest bearing feature. Stockholders' Equity At December 31, 1997, the Company had 1,770,819 shares of Series Preferred Stock with a $1.00 par value authorized, of which 100,000 shares are designated as Series A Preferred Stock. During 1996, the Company designated 32,200 shares as Series B Preferred Stock, $1.00 par value. The Series A Preferred Stock, as well as the undesignated shares of Series Preferred Stock, remains unissued. In 1996, the Company issued all of the 6.05% Series B Preferred Stock in connection with the acquisition of UGS. The Series B Preferred Stock is recorded on the balance sheet at its liquidation value of $100 per share. The dividends, payment of which commenced December 1, 1996, are cumulative and 21 22 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (In thousands of dollars, except per share amounts) payable quarterly. PSC may not pay dividends on common stock unless provision has been made for payment of the preferred dividends. Under the provisions of this issue, the holders may redeem the shares, in whole or in part, at the liquidation value beginning December 1, 1998 and the Company may redeem up to 20% of this issue each year beginning December 1, 2001 and, at the holders' option, this redemption may be made in cash or through the issuance of debt with a five year maturity at an interest rate of 6.05%. As of December 31, 1997, all dividends have been provided for. In December 1997, the Company's Board of Directors declared a 4-for-3 common stock split effected in the form of a 33.3% stock distribution for all common shares outstanding, to shareholders of record on December 15, 1997. Common shares outstanding do not include shares held by the Company in treasury. The new shares were distributed on January 12, 1998. The Company's par value of $.50 per share remained unchanged and $3,276 was transferred from Capital in Excess of Par Value to Common Stock to record the split. All share and per share data for all periods presented have been restated to give effect to the stock split. At December 31, 1997, the Company had 40,000,000 shares of common stock authorized; par value $.50. Shares outstanding at December 31, 1997, 1996 and 1995 were 26,210,654, 25,598,105 and 24,377,496, respectively. Treasury shares held at December 31, 1997, 1996 and 1995 were 376,510, 262,230 and 259,125, respectively. 22 23 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements(continued) (In thousands of dollars, except per share amounts) The following table summarizes the activity of common stockholders' equity: In January 1998, the Company registered 1,100,000 shares of common stock for sale in a public offering that it expects to complete in February 1998. Based on the market price of the Company's common stock in late January 1998, the Company anticipates proceeds of $25,239, net of expenses, from this offering, $28,706 if the underwriters' option to sell an additional 150,000 shares is exercised. The proceeds of this offering will be used to make a $19,000 equity contribution to PSW, that PSW will use to reduce the balance of its revolving credit loan, and to repay short-term debt of the Company. The Company has adopted a Dividend Reinvestment and Direct Stock Purchase Plan in early 1998 that replaced the Customer Stock Purchase Program for PSW's customers, and the Dividend Reinvestment and Optional Stock Purchase Program for existing shareholders. Under the new plan, reinvested dividends will continue to be used to purchase original issue shares of common stock at a five percent discount from the current market value. Under the direct stock purchase program, shares may be purchased by investors throughout the year, instead of during limited subscription periods, at market price and the shares will be purchased by the Company's transfer agent in the open-market at least weekly and will not be original issue shares of stock. The Plans that were replaced exclusively used original issue shares and 489,296, 1,007,633 and 868,068 original issue shares of common stock were sold providing the Company with $7,567, $12,280 and $7,846 of additional capital, after expenses, during 1997, 1996 and 1995, respectively. 23
Capital in Common Treasury excess of Retained stock stock par value earnings Total --------------------------------------------------------------------------- Balance at December 31, 1994 5,979 (3,239) 102,564 38,491 143,795 Net income -- -- -- 18,400 18,400 Dividends -- -- -- (13,546) (13,546) Sale of stock 217 392 7,621 -- 8,230 Repurchase of stock -- (733) -- -- (733) Equity Compensation Plan 1 -- 31 -- 32 Exercise of stock options 27 -- 771 -- 798 --------------------------------------------------------------------------- Balance at December 31, 1995 6,224 (3,580) 110,987 43,345 156,976 --------------------------------------------------------------------------- Net income -- -- -- 20,722 20,722 Dividends -- -- -- (14,795) (14,795) Stock split 3,140 -- (3,140) -- -- Sale of stock 298 693 11,546 -- 12,537 Repurchase of stock -- (760) -- -- (760) Equity Compensation Plan 1 -- 38 -- 39 Exercise of stock options 68 -- 2,008 -- 2,076 --------------------------------------------------------------------------- Balance at December 31, 1996 9,731 (3,647) 121,439 49,272 176,795 --------------------------------------------------------------------------- Net income -- -- -- 22,993 22,993 Dividends -- -- -- (16,129) (16,129) Stock split 3,276 -- (3,276) -- -- Sale of stock 178 506 7,128 -- 7,812 Repurchase of stock -- (2,829) -- -- (2,829) Equity Compensation Plan 1 -- 50 -- 51 Exercise of stock options 108 -- 2,724 -- 2,832 --------------------------------------------------------------------------- Balance at December 31, 1997 $ 13,294 $ (5,970) $ 128,065 $ 56,136 $ 191,525 =========================================================================== 24 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements(continued) (In thousands of dollars, except per share amounts) In August 1997, the Board of Directors approved a resolution authorizing the Company to purchase, from time to time, up to 500,000 shares of its common stock in the open market or through privately negotiated transactions. The remaining number of shares authorized for purchase was adjusted as a result of the 4-for-3 stock split so that the total number of shares authorized for purchase as of December 31, 1997 was 669,612. In 1993, the Board of Directors approved a similar authorization. During 1997, 1996 and 1995, 152,000, 4,339 and 78,912 shares have been purchased at a net cost of $2,284, $52 and $733, respectively. For comparative purposes the number of shares purchased is presented as if they were adjusted for the effect of the 1997 and 1996 stock splits. As of December 31, 1997, 628,145 shares remain available for purchase by the Company. Net Income per Common Share and Equity per Common Share In December 1997, the Company adopted SFAS No. 128, "Earnings per Share" which prescribes two methods for calculating net income per common share: Basic and Diluted methods. These calculations differ from those used in prior periods and as a result all prior period earnings per share data have been restated to reflect the adoption of SFAS No. 128 as well as the 1997 4-for-3 stock split. Basic net income per share is based on the weighted average number of common shares outstanding. Diluted net income per share is based on the weighted average number of common shares outstanding and potentially dilutive shares. The dilutive effect of employee stock options is included in the computation of Diluted net income per share. The adoption of this statement had no effect on the results of operations, financial conditions, or long-term liquidity. The following table summarizes the shares used in computing Basic and Diluted net income per share: Equity per common share was $7.31 and $6.91 at December 31, 1997 and 1996 respectively. These amounts were computed by dividing common stockholders' equity by the number of shares of common stock outstanding at the end of each year. Shareholder Rights Plan The Company has a Shareholder Rights Plan (the "Current Plan") designed to protect the Company's shareholders in the event of an unsolicited unfair offer to acquire the Company. Each outstanding common share is entitled to one Right which is evidenced by the common share certificate. In the event that any person acquires 25% or more of the outstanding common shares or commences a tender or exchange offer which, if consummated, would result in a person or corporation owning at least 30% of the outstanding common shares of the Company, the Rights will begin to trade independently from the common shares and, if certain 24
Years ended December 31, ---------------------------------------------- 1997 1996 1995 ---------------------------------------------- Average common shares outstanding during the period for Basic computation 25,908 24,966 23,803 Dilutive effect of employee stock options 365 296 113 ---------------------------------------------- Average common shares outstanding during the period for Diluted computation 26,273 25,262 23,916 ============================================== 25 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements(continued) (In thousands of dollars, except per share amounts) circumstances occur, including the acquisition by a person of 25% or more of the outstanding common shares, each Right would then entitle its holder to purchase a number of common shares of the Company at a substantial discount. If the Company is involved in a merger or other business combination at any time after the Rights become exercisable, the Rights will entitle the holder to acquire a certain number of shares of common stock of the acquiring company at a substantial discount. The Rights are redeemable by the Company at a redemption price of $.02 per Right at any time before the Rights become exercisable. The Rights will expire on March 1, 1998, unless previously redeemed. At the meeting of the Board of Directors scheduled for February 3, 1998, management is expected to recommend that the Board of Directors adopt a new Shareholder Rights Plan (the "New Plan") to replace the Current Plan. The New Plan, which would expire on March 1, 2008, would be substantially the same as the Current Plan except that the beneficial ownership threshold that would trigger the exercisability of the rights issued to purchase Company Common Stock would be reduced from 25% of the outstanding Common Stock to approximately 20% of the outstanding Common Stock. Employee Stock and Incentive Plans Under the 1994 Equity Compensation Plan ("1994 Plan"), as amended, the Company may grant qualified and non-qualified stock options to officers, key employees and consultants. Officers and key employees may also be granted dividend equivalents and restricted stock. Restricted stock may also be granted to non-employee members of the Board of Directors ("Board"). In May 1996, the Shareholders authorized an increase to the number of shares from 900,000 shares to 1,900,000 shares of common stock for issuance under the 1994 plan, with the maximum number of restricted stock grants limited to 50,000 shares. Awards under this plan are made by the Board of Directors or a committee of the Board. Options under the 1994 plan, as well as the earlier 1988 Stock Option Plan were issued at the market price of the stock on the day of the grant. Options are exercisable in installments ranging from 20% to 33% annually, starting one year from the date of the grant and expire 10 years from the date of the grant. The following table summarizes stock option transactions for the two plans: Options exercised during 1997 ranged in price from $6.47 per share to $11.19 per share. The shares under option at December 31, 1997 are exercisable at prices ranging from $6.59 to $15.14 per share. At December 31, 1997, 439,527 shares were exercisable, and 932,008 options under the 1994 Plan were still available for grant. 25
Years Ended December 31, ------------------------------------------------ 1997 1996 1995 ------------------------------------------------ Options granted 263,333 254,000 241,000 Options terminated (33,405) (38,136) - Options exercised (292,492) (240,201) (106,624) ------------------------------------------------ Net change (62,564) (24,337) 134,376 ================================================ Balance of shares under option 968,137 1,030,701 1,055,038 ================================================ 26 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements(continued) (In thousands of dollars, except per share amounts) Under SFAS No. 123, "Accounting for Stock-Based Compensation", the Company elects to continue to apply the provisions of APB Opinion No. 25 and to provide the proforma disclosure provisions of this statement. Accordingly, no compensation cost has been recognized in the financial statements for stock options that have been granted. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net income available to common stock and Basic and Diluted net income per share would have been reduced to the proforma amounts indicated below: The per share weighted-average fair value at the date of grant for stock options granted during 1997, 1996 and 1995 was $2.90, 1.52 and $1.46 per option, respectively. The fair value of options at the date of grant was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:
Years Ended December 31, ---------------------------------------------- 1997 1996 1995 ---------------------------------------------- Net income available to common stock: As reported $ 22,993 $ 20,722 $ 18,400 Proforma 22,229 20,337 18,048 Basic net income per share: As reported $ 0.89 $ 0.83 $ 0.77 Proforma 0.86 0.81 0.76 Diluted net income per share: As reported $ 0.88 $ 0.82 $ 0.77 Proforma 0.85 0.81 0.75 Dividend equivalents provide the grantee with an amount equal to the dividends paid on a share of common stock over a specified period of time, not to exceed four years, multiplied by the number of dividend equivalents awarded. Payments of these awards are deferred until the completion of certain objectives during a performance period established by a Committee of the Board at the time of grant. A performance period is generally four years but may be adjusted by the Committee to as long as eight years or as short as two years depending on the Company's success in completing the objectives. Dividend equivalents are "compensatory" and, as such, are charged to operating expense over the performance period. The effect of changes to the performance period is accrued when known or projected. The Board granted 103,974, 98,975 and 90,977 dividend equivalents in 1997, 1996 and 1995, respectively, and costs associated with these awards were $330 in 1997, $234 in 1996 and $197 in 1995. During 1997 and 1996, payments associated with the dividend equivalents of $191 and $124, respectively, were made to recipients. 26
1997 1996 1995 ---------------------------------------------- Expected life (years) 10 10 10 Interest rate 6.6% 6.4% 7.4% Volatility 13.8% 14.0% 12.5% Dividend yield 4.0% 5.2% 6.3% 27 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements(continued) (In thousands of dollars, except per share amounts) Restricted stock awards provide the grantee with the rights of a shareholder, including the right to receive dividends and to vote such shares, but not the right to sell or otherwise transfer the shares during the restriction period. During 1997, 1996 and 1995, 3,600, 3,200 and 3,600 shares of restricted stock were granted with a restriction period of six months. The value of restricted stock awards, which are "compensatory", is equal to the fair market value of the stock on the date of the grant less payments made by the grantee and is recognized as expense in the year of the grant. Pension Plans and Other Postretirement Benefits The Company has defined benefit pension plans that cover its full-time employees. Retirement benefits under the plans are generally based on the employee's total years of service and compensation during the last five years of employment. The Company's policy is to fund these plans annually at a level which is deductible for income tax purposes and which provides assets sufficient to meet its pension obligations. As a result of certain limitations imposed by the Internal Revenue Code with respect to payments under qualified plans, the Company, in 1989, adopted a non-qualified Excess Benefit Plan for Salaried Employees in order to prevent certain employees from being penalized by these limitations. The Company also has non-qualified Supplemental Executive Retirement Plans for one current and one retired employee. The net pension costs and obligations of the qualified and non-qualified plans are included in the tables which follow. The Company's pension expense includes the following components: The rate-regulated adjustment set forth above is required in order to reflect pension expense for PSW in accordance with the method used in establishing water rates. 27
Years Ended December 31, ---------------------------------------------- 1997 1996 1995 ---------------------------------------------- Benefits earned during the year $ 1,432 $ 1,373 $ 905 Interest cost on projected benefit obligation 3,796 3,523 3,304 Actual return on plan assets (11,502) (6,784) (9,256) Net amortization and deferral 7,222 2,904 6,029 Capitalized costs (40) (34) (133) Rate-regulated adjustment (567) (707) (311) ---------------------------------------------- Net pension cost $ 341 $ 275 $ 538 ============================================== 28 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements(continued) (In thousands of dollars, except per share amounts) The assets and obligations of the plans are as follows: The accumulated and projected benefit obligations were calculated using the projected unit credit method and reflect the following assumptions: discount rates of 7% for 1997, 7.25% for 1996 and 7% for 1995; increase in future compensation levels of 5.5% for all years presented; and long-term rate of return on assets of 9% for all years presented. In addition to providing pension benefits, PSW offers certain Postretirement Benefits other than Pensions ("PBOPs") to employees retiring with at least 15 years of service. These PBOPs include continuation of medical and prescription drug benefits for all eligible retirees and a life insurance policy for eligible union retirees. The Company's costs for postretirement benefits other than pensions includes the following components: 28
December 31, ------------------------------- 1997 1996 ------------------------------- Accumulated benefit obligation: Vested $ 43,894 $ 38,991 Non-vested 2,443 2,210 ------------------------------- Total $ 46,337 $ 41,201 =============================== Projected benefit obligation $ 57,157 $ 51,321 Plan assets at fair value, primarily equity and fixed income commingled funds 60,112 51,249 ------------------------------- Plan assets less than (in excess of) projected benefit obligation (2,955) 72 Unrecognized net gain from past experience different from that assumed and effects of changes in assumptions 7,715 3,522 Unrecognized prior service cost (1,737) (1,378) Rate-regulated adjustment (1,662) (1,095) Unrecognized net obligation (364) (453) ------------------------------- Accrued pension costs included in other current liabilities $ 997 $ 668 =============================== 29 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements(continued) (In thousands of dollars, except per share amounts) The assets and liabilities of the plans for postretirement benefits other than pensions are as follows:
Years Ended December 31, ---------------------------------------------- 1997 1996 1995 ---------------------------------------------- Benefits earned during the year $ 389 $ 296 $ 208 Interest cost 919 872 994 Return on plan assets (647) (173) (101) Net amortization and deferral 916 567 655 Amortization of regulatory asset 136 136 136 ---------------------------------------------- Gross PBOP cost 1,713 1,698 1,892 Capitalized costs (407) (79) (94) ---------------------------------------------- Net PBOP cost $ 1,306 $ 1,619 $ 1,798 ============================================== The APBO is calculated utilizing the following assumptions: discount rate of 7%; medical inflation rates of 5% for those employees not eligible by December 31, 1993, and 8%, reducing to 4.5% by 2002 for all others; a 9% return on plan assets for all years presented. The effect of a 1% increase in the assumed medical inflation rates would be to increase the APBO and the 1997 PBOP costs by $770 and $59, respectively. The Company funds its gross PBOP cost through various trust accounts. Water Rates On October 23, 1997, the Pennsylvania Public Utility Commission ("PUC") approved a rate settlement reached between PSW and the parties actively litigating the rate application PSW filed in April 1997. The settlement is designed to increase PSW's annual revenue by $9,300 or 7.3% over the level in effect at the time of the filing. The rates in effect at the time of the filing included a 1% or $1,300 Distribution System Improvement Charge ("DSIC"). Consequently, the settlement resulted in a total base rate increase of $10,600 or 8.3%. As a part of the settlement, the DSIC was reset to zero and the Company agreed not to file a base rate increase request prior to April 1999, absent extraordinary circumstances. PSW was permitted by the PUC to increase its base rates by 5.3% effective October 27, 1995 which 29
December 31, ------------------------------- 1997 1996 ------------------------------- Accumulated postretirement benefit obligation (APBO): Retirees $ 6,244 $ 6,246 Fully eligible active employees 2,857 3,325 Other employees 3,626 3,045 ------------------------------- Total APBO 12,727 12,616 Fair value of plan assets 5,437 3,500 ------------------------------- APBO in excess of plan assets 7,290 9,116 Unrecognized net transition obligation (11,151) (11,894) Unrecognized net gain 5,892 4,974 ------------------------------- Accrued PBOP cost included in other liabilities $ 2,031 $ 2,196 =============================== 30 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements(continued) (In thousands of dollars, except per share amounts) was designed to provide additional annual revenues of approximately $6,150. In 1996, the PUC approved PSW's request to add a DSIC to its water bills. The DSIC enabled PSW to add a surcharge to customer bills beginning January 1, 1997 reflecting the capital costs and depreciation related to certain distribution system improvement projects completed and placed into service between base rate filings. PSW is permitted to request adjustments to the DSIC quarterly to reflect subsequent capital expenditures and it is reset to zero when new base rates that reflect the costs of those additions become effective. The maximum DSIC that can be in effect at any time is 5%. The DSIC increased revenues in 1997 by $1,104. In October 1997, the existing DSIC rate of 1.82% was eliminated with the adoption of new base rates. In addition to its base rates, PSW has utilized a surcharge or credit on its bills to reflect certain changes in Pennsylvania State taxes until such time as the tax changes are incorporated into base rates. In October 1995, the existing credit of 1.04% was eliminated with the adoption of new base rates. PSW was required to initiate a revenue credit in 1994 in order to provide its customers with the savings associated with Pennsylvania tax rate decreases. The credit decreased revenues in 1995 by $504. Discontinued Operations The Board of Directors had authorized the sale of substantially all of the Company's non-regulated businesses and the last of these businesses was sold in 1993. At the time the Board of Directors authorized the sale of these businesses, the Company established reserves for: projected operating losses of these businesses subsequent to their sale authorizations; estimated losses on the sale transactions; and certain future costs, including administrative and legal services related to the sales, contingent legal and lease obligations and certain employee costs. These reserves were recorded on the balance sheet net of related income tax benefits. During 1997 and 1996, contingent sale proceeds of $250 and $337 were received and credited to the reserve. During 1996 and 1995, $18 and $178 of payments associated with discontinued operations were charged to the reserve. As a result of the continuing assessment of asserted and unasserted legal claims related to these businesses, the passage of time, which reduced certain lease contingencies, and the receipt of contingent sale proceeds, the Company has determined that, the net reserves were in excess of estimates of potential costs. Consequently, the contingent sale proceeds received in 1997 were included in Earned Revenues. In 1996 and 1995, the Company reversed $965 and $370 net of related income taxes, of these reserves. At December 31, 1997 there remains a balance in the reserve for discontinued operations of $1,009 which is included in other accrued liabilities. 30 31 PHILADELPHIA SUBURBAN CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements(continued) (In thousands of dollars, except per share amounts) Selected Quarterly Financial Data (Unaudited) (in thousands of dollars, except per share amounts) All per share data as presented has been adjusted for the 1997 common stock split effected in the form of a stock distribution. High and low prices of the Company's common stock are as traded on the New York Stock Exchange. 31
Total First Second Third Fourth Year ------------------------------------------------------------------------------------- 1997 - -------------------------------------------------------------------------------------------------------------------------------- Earned revenues $ 31,021 $ 33,315 $ 36,754 $ 35,081 $ 136,171 Operating expenses 13,068 13,295 14,466 15,070 55,899 Net income available to common stock 4,460 5,778 7,323 5,432 22,993 Basic net income per common share 0.17 0.23 0.28 0.21 0.89 Diluted net income per common share 0.17 0.22 0.28 0.21 0.88 Dividend paid per common share 0.152 0.152 0.159 0.159 0.622 Price range of common stock - high 15.47 15.10 18.00 22.18 22.18 - low 11.72 11.44 14.07 15.10 11.44 1996 - -------------------------------------------------------------------------------------------------------------------------------- Earned revenues $ 29,290 $ 30,683 $ 30,831 $ 31,699 $ 122,503 Operating expenses 13,070 12,614 11,757 14,174 51,615 Income, continuing operations 3,968 5,281 5,847 4,661 19,757 Basic income per share, continuing operations 0.16 0.21 0.24 0.18 0.79 Diluted income per share, continuing operations 0.16 0.21 0.23 0.18 0.78 Income, discontinued operations -- -- 365 600 965 Basic and diluted income per share, discontinued operations -- -- 0.02 0.02 0.04 Net income available to common stock 3,968 5,281 6,212 5,261 20,722 Basic net income per common share 0.16 0.21 0.26 0.20 0.83 Diluted net income per common share 0.16 0.21 0.25 0.20 0.82 Dividend paid per common share 0.145 0.145 0.152 0.152 0.594 Price range of common stock - high 11.57 12.57 12.94 14.91 14.91 - low 10.26 11.25 11.63 12.38 10.26 32 EXHIBIT 99.2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands of dollars, except per share amounts) This report contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. These forward-looking statements include statements regarding the Company's development, growth and expansion plans and the sufficiency of the Company's liquidity and capital. These statements are based on assumptions made by management regarding future circumstances over which the Company may have little or no control. Actual results may differ materially from these forward-looking statements for a number of reasons, including (i) the effects of regulation, (ii) changes in capital requirements and funding, and (iii) acquisitions. Following are selected five-year financial statistics for the Company: *Includes dividends on preferred stock of PSW with mandatory redemption requirements. 32
Years ended December 31, 1997 1996 1995 1994 1993 - --------------------------------------------------------------------------------------------------------------- Earned revenues $ 136,171 $ 122,503 $ 117,044 $ 108,636 $ 101,244 - --------------------------------------------------------------------------------------------------------------- Income from continuing operations before income taxes $ 39,061 $ 33,749 $ 30,931 $ 27,209 $ 24,261 - --------------------------------------------------------------------------------------------------------------- Operating Statistics Earned revenues 100.0% 100.0% 100.0% 100.0% 100.0% Costs and expenses: Operating expenses 41.1% 42.1% 44.2% 46.3% 45.4% Depreciation and amortization 10.7% 10.9% 9.9% 9.5% 10.8% Taxes other than income taxes 6.5% 6.8% 6.6% 6.6% 6.8% Interest expense* 13.4% 12.9% 13.2% 12.7% 13.8% Allowance for funds used during construction (0.4)% (0.2)% (0.3)% (0.1)% (0.8)% - --------------------------------------------------------------------------------------------------------------- Total costs and expenses 71.3% 72.5% 73.6% 75.0% 76.0% - --------------------------------------------------------------------------------------------------------------- Income from continuing operations before income taxes 28.7% 27.5% 26.4% 25.0% 24.0% =============================================================================================================== Effective tax rates 40.6% 41.4% 41.7% 42.5% 43.0% =============================================================================================================== Income from continuing operations as a percentage of average stockholders' equity 12.4% 11.7% 12.0% 11.2% 11.4% =============================================================================================================== 33 Following are selected five-year operating and sales statistics for PSW: General Information Philadelphia Suburban Corporation ("PSC" or the "Company"), a Pennsylvania corporation, is the holding Company of Philadelphia Suburban Water Company ("PSW"), a regulated water utility. PSW provides water service to approximately 288,000 customers in 93 municipalities within its 464 square mile service territory. In addition, PSW provides water service to approximately 6,000 customers through an operating and maintenance contract to a municipal authority located contiguous to its service territory. PSW's service territory is located in Pennsylvania, north and west of the City of Philadelphia. Results of Operations Income from continuing operations of the Company has grown at an annual compound rate of approximately 16.9% during the five-year period ended December 31, 1997. During this same period, revenues and total expenses, other than income taxes, have grown at compound rates of 7.9% and 5.4%, respectively. Earned Revenues The growth in revenues over the past five years is a result of increases in the customer base and in water rates. The number of customers increased at an annual compound rate of 33
Years ended December 31, 1997 1996 1995 1994 1993 - -------------------------------------------------------------------------------------------------------------- Daily sendout (Million gallons Maximum 142.5 109.5 121.8 110.4 120.7 per day) Average 103.8 94.2 92.6 89.8 89.1 ======================================================================= Metered Residential 268,550 265,746 248,500 234,624 232,684 customers Commercial 13,512 13,422 12,019 11,071 11,014 Industrial 708 716 554 539 538 Other 4,746 4,257 3,792 3,299 2,959 ----------------------------------------------------------------------- Total 287,516 284,141 264,865 249,533 247,195 ======================================================================= Consumption per customer in gallons Average 110,143 103,206 109,084 109,001 110,368 ======================================================================= Revenues from Residential $ 88,542 $ 79,056 $ 77,744 $ 69,483 $ 66,656 water sales Commercial 28,048 26,504 24,368 23,431 20,506 Industrial 5,170 4,823 4,512 4,737 4,207 Other 10,874 9,950 9,249 9,151 8,092 ----------------------------------------------------------------------- Total $132,634 $120,333 $115,873 $106,802 $ 99,461 ======================================================================= 34 3.3% in the past five years primarily as a result of acquisitions of local water systems. Acquisitions made during the five year periods ended December 31, 1997, 1996 and 1995 have provided water revenues of approximately $11,460, $8,210 and $5,550 in 1997, 1996 and 1995, respectively. Excluding the effect of acquisitions, the customer base increased at a five-year annual compound rate of .8%. Water rates have increased at an annual compound growth rate of 4.5% over the five-year period. Rates charged by PSW for water service are subject to the approval of the Pennsylvania Public Utility Commission ("PUC"). PSW continuously reviews the necessity of filing applications with the PUC for increases in rates charged for water service. Among the factors considered by management in determining the need to apply for increased rates are: the amount of utility plant additions and replacements made since the previous rate decision; changes in the cost of capital and the capital structure of PSW; and increases in operating expenses (including wages, fringe benefits, electric and chemical expenses), depreciation and taxes experienced since the previous rate decision. Based on these assessments, PSW periodically files requests with the PUC to increase its rates. Typically, the PUC will suspend the rate request for up to nine months during which time evidentiary hearings on the merits of the request are held. The positions of PSW as well as the PUC staff, the Office of Consumer Advocate ("OCA") and other interested parties are presented and evaluated during these hearings. In 1996, the PUC approved a mechanism, the Distribution System Improvement Charge ("DSIC"), which allows Pennsylvania water utilities to add a surcharge to their water bills to offset the additional depreciation and capital costs associated with certain non-revenue producing, non-expense reducing capital expenditures related to replacing and rehabilitating distribution systems. The DSIC mechanism is intended to eliminate many of the disincentives faced by water utilities in rehabilitating their distribution systems. These disincentives, often referred to as regulatory lag, are due to the rate making process which, prior to the establishment of the DSIC mechanism, required water utilities to absorb all of the depreciation and capital costs of these projects between base rate increases without the benefit of additional revenues. The DSIC may be adjusted quarterly based on additional qualified capital expenditures made in the previous quarter but may never exceed 5% of the base rates in effect. The DSIC is reset to zero when new base rates that reflect the costs of those additions become effective. PSW began charging a DSIC of .5% in the first quarter of 1997. Based on subsequent qualified capital expenditures the DSIC was increased to 1.0% in the second quarter, 1.4% in the third quarter and 1.82% for the portion of the fourth quarter prior to the effective date of the new base rate increase. Total revenues associated with the DSIC in 1997 were $1,104. In April 1997, PSW filed an application with the PUC to increase its rates by 13.2%. The request was suspended to allow the PUC Staff, the OCA and other interested parties a period of additional discovery and to hold hearings on the merits of this request. Prior to the commencement of hearings, PSW reached a settlement with the OCA and the other interested parties. The settlement, which was subsequently approved by the PUC, provided for a 7.3% increase over the rates that were in effect at the time of the filing. Since rates in effect at the time of the filing included a DSIC of 1% or $1,300 on an annual basis, the settlement resulted in a total base rate increase of 8.3% or $10,600 on an annual basis. The new base rates were effective on October 24, 1997. As part of the settlement, PSW has agreed not to file its next 34 35 base rate increase request prior to April 1999, absent extraordinary circumstances. As a result of the rate settlement, the DSIC was reset to zero. In the years prior to 1997, rates were increased 5.3%, 9.1% and 7.4% in 1995, 1994, and 1993, respectively. In recent years, the most significant factor in determining the need for a rate increase and the actual rate increases granted has been the amount of utility plant additions that PSW has made, including acquisitions, and the costs of the capital used to finance these additions. In addition to increases in base rates, the PUC has adjusted rates by means of a surcharge or credit to reflect changes in the tax laws, which were not reflected in the base rates approved by the PUC. These adjustments are eliminated when the tax changes are reflected in base rates. During 1995 and 1994, rates were reduced by various credits as a result of reductions in Pennsylvania taxes. These credits resulted in revenue reductions of $504 in 1995 and $97 in 1994. "Sendout" represents the quantity of treated water delivered to the distribution system and is used by management as an indicator of customer demand. Consumption per customer is the sendout that was used by metered customers and is based on the actual bills rendered during the year adjusted for the estimated unbilled customer usage. Water consumption tends to be impacted by weather conditions, particularly during the late spring and summer months when nonessential and recreational use of water is at its highest. Consequently, a higher proportion of annual operating revenues is realized in the second and third quarters. It is difficult to establish an exact correlation between the weather and water consumption, since conservation and even day-to-day variations in weather patterns can have a significant effect. Conservation efforts, construction codes which require the use of low flow plumbing fixtures as well as mandated water use restrictions in response to drought conditions also may have an effect on water consumption. Over the past five years, sendout has increased primarily as a result of PSW's growth in customers. The average annual consumption per customer increased in 1997 by 6.7% and declined by 5.4% in 1996 but has only varied slightly in the previous three years. The increase in the average consumption per customer in 1997 is attributable to the relatively hot, dry summer weather experienced in 1997, particularly in comparison to 1996 when average consumption per customer declined due to rainfalls that were well above average and temperatures that were cooler than normal during the spring and summer months. Operating Expenses Operating expenses for 1997, 1996 and 1995, totaled $55,899, $51,615 and $51,702, respectively. Most elements of operating expense are subject to the effects of inflation, as well as the effects of changes in the number of customers served, in water consumption and the degree of treatment required due to variations in the quality of the raw water. The principal elements of operating costs are labor, electricity, chemicals and maintenance expenses. Electricity and chemical expenses vary in relationship to water consumption and raw water quality. Maintenance expenses are sensitive to extreme cold weather, which can cause water mains to rupture. 35 36 Operating expenses increased in 1997 over 1996 by $4,284 or 8.3% primarily as a result of the operating expenses of the water systems acquired in 1997 and 1996 of $1,883, higher production costs resulting from the increased volume of water sold of $740, and increased wage and administrative expenses, partially offset by lower maintenance expenses. Administrative costs increased as a result of increases in insurance costs, and in the bad debt reserve which is related to the increase in revenues. Maintenance expenses declined due to fewer main breaks as a result of the effects of the relatively mild 1997 winter. Operating expenses decreased slightly in 1996 over 1995 primarily as a result of reductions in pension, employee medical insurance premiums and general liability insurance costs offset in part by the additional operating expenses associated with the acquisitions made in 1996 and 1995. Pension expense declined as a result of the investment returns in the previous two years on the pension assets. Medical insurance costs declined as a result of favorable claims experience with the carriers and the movement of a majority of employees from indemnity health plans to managed care plans. For the past three years, corporate costs were less than 1% of the Company's operating expenses. Such expenses include those unallocated general and administrative expenses associated with maintaining a publicly-held company. Depreciation and Amortization Depreciation expense was $14,311, $13,068 and $11,572 in 1997, 1996 and 1995, respectively, and has increased principally as a result of the significant capital expenditures made to expand and improve the water utility facilities, and as a result of acquisitions of water systems. Depreciation expense was approximately 2.3% of the average utility plant in service for 1997 and 1996, respectively. Amortization was a charge of $269 in 1997, $265 in 1996 and a credit of $15 in 1995. The increase in 1997 is due to the amortization of additional debt issuance expenses and amortization of the costs of PSW's 1997 rate filing, offset in part by the completion of amortization of the costs of PSW's 1995 rate filing. Expenses associated with filing rate cases are deferred and amortized over approximately 18 months. The increase in 1996 over 1995 is due to the amortization of the costs of PSW's 1995 rate filing as well as the amortization of additional debt issuance expenses. Taxes Other than Income Taxes Taxes other than income taxes increased by approximately 8% in both 1997 and 1996 over the previous year. The majority of the increase in both years is associated with increases in the base on which the Pennsylvania Public Utility Realty Tax (PURTA), local real estate taxes and the Capital Stock Tax are calculated and to an increase in the PURTA tax rate. The increase in the taxable base for the PURTA and local real estate taxes is due to the capital expenditures, and the acquisitions completed in the last three years. The increase in the Capital Stock Tax is due to the increases in the Company's common equity over the past three years. Interest Expense Interest expense was $17,890, $15,311, and $14,852 in 1997, 1996 and 1995, respectively, and has increased in 1997 and 1996 primarily as a result of higher levels of 36 37 borrowing offset in part by a reduction in interest rates. The level of debt increased in order to finance acquisitions and other capital expenditures made since 1995. Allowance for Funds Used During Construction The allowance for funds used during construction ("AFUDC") was $522, $264 and $305 in 1997, 1996 and 1995, respectively, and has varied over the years as a result of changes in the average balance of utility plant construction work in progress ("CWIP"), to which AFUDC is applied, and to changes in the AFUDC rate. The average balance of CWIP to which AFUDC is applied was $8,641, $4,441 and $4,848 in 1997, 1996 and 1995, respectively. The increase in 1997 in the average balance of CWIP was due to the increased level of capital expenditures in 1997 as compared to 1996. The decrease in 1996 is due to a $4,945 operations center that was under construction during 1995 and placed in service in December 1995. AFUDC is not applied to projects after they are placed in service, but is applied to an ever-increasing base during the period they are under construction. The AFUDC rate has varied due to changes in the interest rate on PSW's revolving credit facility. The average AFUDC rate was 6.1%, 6.1% and 6.3% in 1997, 1996 and 1995, respectively. Income Taxes The Company's effective income tax rate was 40.6% in 1997 as compared to 41.4% in 1996 and 41.7% in 1995. The changes in the effective tax rates in 1997 and 1996 are due to differences between tax deductible expenses and book expenses. Discontinued Operations In 1993, the Company completed the sale of the last of the nonregulated businesses that the Board of Directors authorized in 1990 and 1991. These businesses are accounted for as discontinued operations. In connection with the decision to sell these businesses, the Company established reserves to cover future costs and contingencies that the Company could be required to pay. In 1996 and 1995, the Company reversed $965 and $370, net of related income taxes, of the reserves. The reversals were made as a result of: the receipt of contingent sales proceeds from two of the businesses that were sold; the passage of time, which reduced certain potential lease obligations; and the assessment of current information on asserted and unasserted legal claims related to these businesses. In 1997, the Company received additional sale proceeds of $250 from one of the businesses sold and included the amount in Earned Revenues. The balance of the reserves for discontinued operations of $1,009 at December 31, 1997 consists primarily of reserves for future and contingent costs including potential lease, legal and insurance costs associated with these businesses. Summary 37 38 Operating income in 1997, 1996 and 1995 was $56,799, $49,290 and $46,109, respectively, and income from continuing operations was $23,188, $19,778 and $18,030, respectively, for the same periods. Diluted income per share from continuing operations in 1997, 1996 and 1995 was $.88, $.78 and $.75, respectively. The increases in the per share income in 1997 and 1996 over the previous years were due to the aforementioned improvements in profits offset in part by a 4.0% and 5.6% increase in the average number of common shares outstanding during 1997 and 1996, respectively. Although the Company has experienced increased income in the recent past, continued adequate rate increases reflecting increased operating costs and new capital investments are important to the future realization of improved profitability. Fourth Quarter Results Net income available to common stock for the fourth quarter of 1997 increased over the same period in 1996 by $171 to $5,432 primarily as a result of a $3,382 increase in revenues offset in part by an increase in operating expenses, depreciation, amortization, taxes other than income, interest expense and preferred dividends, and to the absence, in 1997, of the reversal of reserves for discontinued operations. The increase in revenues was primarily a result of the acquisitions made during the past two years, the rate increase, which took effect October 24, 1997 and an increase in water sales. Operating expenses increased primarily due to costs associated with the acquisitions and the increased water sales. Depreciation increased due to utility plant additions and the acquisitions made since the fourth quarter of 1996. Amortization increased due to the amortization of the costs associated with the 1997 rate request filing. Taxes other than income taxes increased primarily because of the increase in the base on which the PURTA and Capital Stock Tax are computed and to an increase in the PURTA tax rate. Interest increased in the fourth quarter primarily as a result of higher borrowing levels. Effects of Inflation As a regulated enterprise, PSW's rates are established to provide recovery of costs and a return on its investment. Recovery of the effects of inflation through higher water rates is dependent upon receiving adequate and timely rate increases. However, rate increases are not retroactive and often lag increases in costs caused by inflation. During periods of moderate to low inflation, as has been experienced for the past several years, the effects of inflation on PSW's operating results are not significant. Year 2000 Except for its customer information system, the Company's management information systems are year 2000 compliant in all material respects. The Company is currently installing a new customer information system which, in addition to being year 2000 compliant, will offer additional functionality and will be scalable to meet future customer growth. The installation of the new customer information system will be completed in 1998 and the cost of this system, including installation and conversion from the existing system, is currently estimated at approximately $3,140. Electric Deregulation 38 39 During 1997, the total costs for electric power purchased by the Company amounted to $8,575. In December 1996, the Governor of Pennsylvania signed into laws the Electricity Generation Customer Choice and Competition Act ("Electric Act") which provides for the restructuring of the electric utility industry in Pennsylvania. The Electric Act requires the unbundling of electric services into separate generation, transmission and distribution services with open competition for generation. Beginning in November 1997, approximately 18% of PSW's electricity requirements were selected to be included in the State's pilot implementation program. Prior to the pilot program, PSW had purchased all of its electricity from PECO Energy Company ("PECO"). For electric accounts in the pilot program, the electricity will be purchased from HorizonOne Electric, a PECO affiliate. The total electric costs for the twelve-month period prior to the pilot program for the accounts selected were approximately $1,020. The Company estimates that the electric rates during participation in the pilot program will be approximately 10% to 12% lower than the former rates. Since electric usage is dependent on water demand, the exact savings related to the pilot program cannot be determined at this time. A recent ruling by the PUC provides that after completion of the pilot program on December 31, 1998, 66% of PECO's electric accounts, including the accounts in the pilot program and others to be selected in a lottery, will be permitted to choose the electricity generator of their choice. The Electric Act will be completely phased in on January 1, 2001 at which point all electric accounts will be allowed to select their electric supplier. The PUC ruling is subject to appeal by PECO and others. Financial Condition Cash Flow and Capital Expenditures Net operating cash flow, dividends paid on common stock and capital expenditures, including allowances for funds used during construction, for the five years ended December 31, 1997 were as follows: Included in capital expenditures are: $11,650 for the construction of a surface water treatment plant; $15,189 for the modernization of existing treatment plants; $20,084 for new water mains and customer service lines; $30,101 for the rehabilitation of existing water mains; $9,835 to rehabilitate hydrants and customer service lines; $19,238 for water meters and $4,945 for the construction of a divisional operations center. During this five year period, PSW received $7,702 of advances and contributions in aid of construction to finance new water mains. In 39
- -------------------------------------------------------------------------------- Net Operating Common Capital Cash Flow Dividends Expenditures - -------------------------------------------------------------------------------- 1993 $ 27,049 $ 11,629 $ 27,958 1994 29,730 12,637 27,379 1995 32,954 13,546 33,182 1996 37,422 14,795 31,389 1997 41,843 16,129 38,960 - -------------------------------------------------------------------------------- $168,998 $ 68,736 $158,868 ================================================================================ 40 addition to its capital program, PSW has made sinking fund contributions aggregating $3,536, retired $71,700 of debt and $5,786 of preferred stock, and has refunded $9,639 of customer advances for construction. PSW has also expended $71,634 related to the acquisition of 19 water systems and 2 small wastewater utilities since 1993. Since net operating cash flow to PSW plus advances and contributions in aid of construction have not been sufficient to fully fund its cash requirements, PSW issued approximately $141,000 of First Mortgage Bonds, and received $32,495 of equity investments from the Company during the past five years. The Company has funded its investment in PSW with the proceeds from the sale of stock and the sale of its discontinued operations. In April 1993, the Company sold 2,200,000 shares of common stock in a public offering for net proceeds of $18,331. The Company has also sold 3,901,636 original issue shares of common stock for net proceeds of $41,423 since 1993 through three programs that allowed existing shareholders and customers of PSW to purchase shares of common stock directly from the Company as described in the following table: In December 1997, the Company adopted a Dividend Reinvestment and Direct Stock Purchase Plan ("Plan") that replaced the Customer Stock Purchase Plan and the Dividend Reinvestment and Optional Stock Purchase Plan. Under the direct stock purchase portion of the Plan, shares are sold throughout the year, instead of during quarterly subscription periods, and the shares are obtained by the Company's transfer agent in the open market instead of original issue shares of stock. The dividend reinvestment portion of the Plan continues to offer a 5% discount on the purchase of original issue shares of common stock with reinvested 40
Customer Optional Stock Dividend Stock Purchase Reinvestment Purchase Program Program Program Total - ------------------------------------------------------------------------------------ Net proceeds: 1993 $ 5,465 $ 1,491 $ 583 $ 7,539 1994 3,541 2,047 603 6,191 1995 4,680 2,324 842 7,846 1996 7,953 3,111 1,216 12,280 1997 3,122 3,650 795 7,567 - ------------------------------------------------------------------------------------ $ 24,761 $ 12,623 $ 4,039 $ 41,423 ==================================================================================== Shares issued: 1993 597,880 173,408 63,715 835,003 1994 401,380 234,040 66,216 701,636 1995 510,911 265,820 91,337 868,068 1996 644,151 266,129 97,353 1,007,633 1997 201,092 237,437 50,767 489,296 - ------------------------------------------------------------------------------------ 2,355,414 1,176,834 369,388 3,901,636 ==================================================================================== 41 dividends. As of the December 1997 dividend payment, holders of 23% of the common shares outstanding participated in the dividend reinvestment portion of the Plan. In August 1997, the Board of Directors approved a resolution authorizing the Company to purchase 500,000 shares of its common stock in the open market or through privately negotiated transactions. A similar resolution was approved in 1993. Management has used this authority, from time to time, to offset the dilutive effect on earnings per share resulting from the original issue shares issued through the plans previously discussed. During 1997, 1996 and 1995, the Company purchased 152,000, 4,339 and 78,912 shares at a net cost of $2,284, $52 and $733, respectively. (For comparative purposes, the numbers of shares in the previous sentence have been adjusted to give effect to the 1997 4-for-3 common stock split in the form of a stock distribution). As of December 31, 1997, the remaining number of shares the Company may purchase under the Board of Director's authorization is 628,145. Funding for future stock purchases, if any, is not expected to have a material impact on the Company's financial position. PSW's planned 1998 capital program, exclusive of the costs of new mains financed by advances and contributions in aid of construction, is estimated to be $55,000 of which $33,400 is for DSIC qualified projects. PSW has increased its capital spending for infrastructure rehabilitation in response to the DSIC. Should the DSIC be discontinued for any reason, which is not anticipated, PSW would likely reduce its capital program significantly. The 1998 capital program, along with the January 1998 acquisition of the water utility assets of the West Chester Area Municipal Authority, $2,448 of sinking fund obligations and $4,214 of preferred stock redemptions is expected to be financed through internally-generated funds, the revolving credit facility, equity investments from the Company, and issuance of new long-term debt. In January 1998, the Company registered 1,100,000 of shares of common stock for sale in a public offering that it expects to complete in February 1998. Based on the market price of the Company's common stock in late January 1998, the Company anticipates proceeds of $25,239, net of expenses, from this offering, $28,706 if the underwriters' option to sell an additional 150,000 shares is exercised. The proceeds of this offering will be used to make a $19,000 equity contribution to PSW and to repay short-term debt. PSW continues to hold acquisition discussions with several water systems that are near or adjacent to PSW's service territory. The cash needed for acquisitions is expected to be funded initially with short-term debt with subsequent repayment from the proceeds of long-term debt or equity investments from the Company. Future utility construction in the period 1999 through 2002, including recurring programs, such as the ongoing replacement of water meters, the rehabilitation of water mains and additional transmission mains to meet customer demands, exclusive of the costs of new mains financed by advances and contributions in aid of construction, is estimated to require aggregate expenditures of approximately $200,000, the majority of which will be DSIC qualified projects to rehabilitate the distribution system. The Company anticipates that approximately 50% of these expenditures will require external financing including the additional issuance of Common Stock through the Company's dividend reinvestment plan and possible future public equity offerings. The Company expects to refinance $20,238 of debt maturities during this period as they become due with new issues of long-term debt. The 41 42 estimates discussed above do not include any amounts for possible future acquisitions of water systems or the financing necessary to support them. PSW's ability to finance its future construction programs, as well as its acquisition activities, depends on its ability to attract the necessary external financing and maintain or increase internally-generated funds. Rate orders permitting compensatory rates of return on invested capital and timely rate adjustments will be required to allow PSW to achieve an adequate level of earnings to enable it to secure the capital it will need and to maintain satisfactory debt coverage ratios. Capitalization The following table summarizes PSC's capitalization during the past five years: * includes current portion. The changes in the capitalization ratios result from the issuance of common stock over the past five years, particularly in 1993, and the issuance of debt by PSW to finance its acquisitions and capital program. It is the Company's and PSW's goal to maintain an equity ratio adequate to support PSW's current Standard and Poors debt rating of "A" and the expected issuance of common stock in an underwritten public offering in February 1998 will increase its common equity ratio. Impact of Recent Accounting Pronouncements In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128") which introduces new methods for calculating earnings per share. The Company adopted this Statement, as required, in December 1997. The adoption of this Statement required the Company to restate earnings per share reported in prior periods. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The Company plans to adopt this Statement on January 1, 1998, as required. 42
December 31, 1997 1996 1995 1994 1993 - ---------------------------------------------------------------------------------------------------------------- Long-term debt* 54.2% 55.3% 53.5% 49.9% 50.7% Preferred stock * 1.7% 2.1% 2.0% 3.3% 3.4% Common stockholders' equity 44.1% 42.6% 44.5% 46.8% 45.9% - ---------------------------------------------------------------------------------------------------------------- 100.0% 100.0% 100.0% 100.0% 100.0% ================================================================================================================ 43 In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"). This Statement established standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosure about products and services, geographic areas and major customers. The Company plans to adopt this statement on January 1, 1998, as required. The adoption of this Statement will not affect results from operations, financial conditions or long-term liquidity. Dividends on Common Stock Following is a recent history, adjusted for the 1997 4-for-3 common stock split in the form of a stock distribution, of the Company's income from continuing operations and dividends: Dividends have averaged approximately 77% of income from continuing operations during this period. During 1997, the Board of Directors increased the dividend rate by 7%. As a result, beginning with the dividend payable in March 1998, the annual dividend rate increased to $.65 per share. 43
- -------------------------------------------------------------------------------- Basic Income per share from Cash dividend continuing Payout per common share operations ratio - -------------------------------------------------------------------------------- 1993 $0.54 $0.64 84% 1994 0.55 0.68 81% 1995 0.57 0.75 76% 1996 0.59 0.79 75% 1997 0.62 0.89 70% - -------------------------------------------------------------------------------- 44 EXHIBIT 99.3 SUMMARY OF SELECTED FINANCIAL DATA Philadelphia Suburban Corporation and Subsidiaries (in thousands of dollars, except per share amounts) - -------------------------------------------------------------------------------- *Share and per share data has been restated for the 1997 4-for-3 stock split. (a) Continuing operations only. (b) Includes dividend on preferred stock of subsidiary and is net of allowance for funds used during construction. (c) Includes current portion. (d) Excludes payments for acquired water systems of $1,226 in 1997, $42,122 in 1996, $26,351 in 1995, $612 in 1994 and $1,323 in 1993. 44
Years ended December 31, 1997 1996* 1995* 1994* 1993* ---- ---- ---- ---- ---- PER COMMON SHARE: Income from continuing operations Basic $ 0.89 $ 0.79 $ 0.75 $ 0.68 $ 0.64 Diluted 0.88 0.78 0.75 0.68 0.64 Net income Basic 0.89 0.83 0.77 0.68 0.64 Diluted 0.88 0.82 0.77 0.68 0.64 Cash dividends 0.62 0.59 0.57 0.55 0.54 Return on average shareholders' equity (a) 12% 12% 12% 11% 11% Book value at year end $ 7.31 $ 6.91 $ 6.44 $ 6.14 $ 5.95 Market value at year end 22.17 14.91 10.38 9.06 9.19 - ------------------------------------------------------------------------------------------------------------- INCOME STATEMENT HIGHLIGHTS: Earned revenues (a) $136,171 $122,503 $117,044 $108,636 $101,244 Depreciation and amortization (a) 14,580 13,333 11,557 10,330 10,935 Interest expense (a) (b) 17,738 15,541 15,178 13,636 13,169 Income before income taxes (a) 39,061 33,749 30,931 27,209 24,261 Provision for income taxes (a) 15,873 13,971 12,901 11,571 10,426 Income from continuing operations 23,188 19,778 18,030 15,638 13,835 Net income available to common stock 22,993 20,722 18,400 15,638 13,835 - ------------------------------------------------------------------------------------------------------------- BALANCE SHEET HIGHLIGHTS: Total assets $618,472 $582,944 $518,051 $460,062 $440,935 Property, plant and equipment, net 534,483 502,938 436,905 385,709 366,230 Stockholders' equity 194,745 180,015 156,976 143,795 135,934 Preferred stock with mandatory redemption (c) 4,214 5,643 7,143 10,000 10,000 Long-term debt (c) 234,919 229,962 188,985 153,082 150,176 Total debt 245,319 235,522 195,440 157,132 150,995 - ------------------------------------------------------------------------------------------------------------- ADDITIONAL INFORMATION: Net cash flows from operating activities (a) $ 41,843 $ 37,422 $ 32,954 $ 29,730 $ 27,049 Capital additions (a) (d) 38,960 31,389 33,182 27,379 27,958 Dividends on common stock 16,129 14,795 13,546 12,637 11,629 Number of metered water customers 287,516 284,141 264,865 249,533 247,195 Number of shareholders of common stock 13,894 13,650 12,209 11,243 10,811 Common shares outstanding (000) 26,210 25,598 24,377 23,436 22,860 Employees (full-time) 531 540 535 525 523 - -------------------------------------------------------------------------------------------------------------