Aqua America (WTR)

year. In all cases, payment of the dividend equivalents is conditioned on the grantee being a full-time employee of the Company or its subsidiaries on the March 1 preceding the payment date, unless the grantee’s termination was a result of death, disability or retirement, as defined in the Equity Compensation Plan.

     From time to time, the Committee will make restricted stock grants that vest at the end of a given period of time or in increments over a period of years on the anniversaries of the grant date, in either case, subject to achievement of certain performance criteria. For the restricted stock grants made to date, these performance criteria require an increase in our annual operating income over previous periods.

     Awards of stock options, dividend equivalents and restricted stock are generally all made on the same grant date. The Compensation Committee bases its equity incentive awards for the executives each year on the competitive levels for these awards as described above and does not consider any increase or decrease in the value of past equity incentive awards in making this decision. The Compensation Committee has the discretion to accelerate the vesting of stock options and restricted stock grants and shorten the payment date for dividend equivalents despite the failure to achieve the designated performance criteria.

     In considering the number of stock options to be granted in total to all employees each year, the Compensation Committee considers the number of options outstanding and the number of options to be awarded as a percentage of Aqua America’s total shares outstanding. The number of options granted annually to all employees has been less than 1.0% of Aqua America’s total shares outstanding.

     It is our long-standing practice to set the exercise price for stock options equal to the fair market value of Aqua America’s stock on the date of grant, which for 2007 and 2008 was the closing price for our common stock on the date of grant. It is our policy to make the grant date of equity compensation grants (options, dividend equivalents and restricted stock) the date that the Compensation Committee approves the grants, which is either the date of the Committee’s meeting or the date of the Board meeting following the Committee’s meeting. The meeting dates for all Board and Compensation Committee meetings, including the dates for the Compensation Committee to approve the equity grants is set in the fall of the preceding year for the coming year, subject to changes for scheduling conflicts, and is independent of the timing of our disclosure of any material non-public information other than our normal annual earnings release.

     As set forth in Proposal No. 2 starting on page 39, we are requesting that the shareholders approve a new Omnibus Equity Compensation Plan to replace the 2004 Equity Compensation Plan. The new Plan includes additional types of equity awards, such as restricted stock units and stock appreciation rights, which we believe are commonly included in equity compensation plans of other companies. We feel that providing this broader array of equity-based awards will allow the Committee more flexibility to tailor future equity grants to best meet the Company’s objectives for such awards. If the new Omnibus Equity Compensation Plan is approved by the shareholders, a maximum of 5,000,000 shares will be issued under the Plan, subject to adjustments as provided in the Plan, and no further grants will be made under the 2004 Equity Compensation Plan.

     Stock options have been the predominant form of equity incentive used by the Compensation Committee, since the Compensation Committee believes that stock options have provided a cost-effective method of achieving the objectives of the equity incentives. Dividend equivalents are used to supplement the stock option awards and to motivate executive performance to achieve results that will enable us to increase dividends for our shareholders. The Compensation Committee generally awards a number of dividend equivalents equal to the number of shares underlying stock options awarded to the executives each year. The Compensation Committee has used restricted stock on a selective basis to supplement the option and dividend equivalent awards to achieve target equity incentive levels for certain executives and as a retention tool for selected executives. The actual number of stock options, dividend equivalents and shares of restricted stock granted each year to the named executive officers is determined by the Committee so that the value of these awards when combined with the named executive officers’ base salary and target annual cash incentives, brings the named executive officers’ total direct compensation generally within 15% of the target total direct compensation for these positions, taking into account the period over which restricted stock awards are projected to vest.

     Each dividend equivalent entitles the grantee to receive in the future an amount of cash compensation equal to the dividends paid by Aqua America on a share of Common Stock for a particular period of time referred to as the accumulation period. For the dividend equivalents awarded to date, the Compensation Committee has set this accumulation period as four years from the date of grant. As part of the dividend equivalent award, the Compensation Committee also sets a target payment date for the dividend equivalents. For the dividend equivalents awarded to date, the Compensation Committee has set this payment date at four years from the date of grant. Under the terms of the Equity Compensation Plan, the actual payment date can be shortened to two years or lengthened to up to eight years depending on our achievement of annual performance criteria established by the Compensation Committee each year. If the payment date is shortened to less than four years, the executive will receive on the payment date any dividend equivalents accrued as of that date and will receive the balance of the applicable dividend equivalents on Aqua America’s quarterly dividend payment dates through the end of the accumulation period. The performance criteria for determining the payment date consist of increasing the dividend paid to shareholders and achieving an increase in annual operating income over the prior year. If both criteria are achieved, the payment date is shortened by one year. If neither criteria is achieved, the payment date is lengthened by one year. If only one of the criteria is achieved, there is no change to the payment date. The performance criteria are the same for all executives that are granted dividend equivalents each year.

     Restricted stock grants can vest in a given period of time or in increments over a period of years on the anniversaries of the grant date, subject to our achievement of certain performance criteria. These performance criteria require an increase in our annual operating income over previous periods.

     Awards of stock options, dividend equivalents and restricted stock are generally all made on the same grant date. The Compensation Committee bases its equity incentive awards for the executives each year on the competitive levels for these awards as described above and does not consider any increase or decrease in the value of past equity incentive awards in making this decision. The Compensation Committee has the discretion to accelerate the vesting of stock options and shorten the payment date for dividend equivalents despite the failure to achieve the designated performance criteria.

     In considering the number of stock options to be granted in total to all employees each year, the Compensation Committee considers the number of options outstanding and the number of options to be awarded as a percentage of Aqua America’s total shares outstanding. The number of options granted annually to all employees has been less than 1.0% of Aqua America’s total shares outstanding.

     It is our long-standing practice to set the exercise price for stock options equal to the fair market value of Aqua America’s stock on the date of grant, which for 2007 was the closing price for our common stock on the date of grant. It is our policy to make the grant date of equity compensation grants (options, dividend equivalents and restricted stock) the date that the Compensation Committee approves the grants, which is either the date of the Committee’s meeting or the date of the Board meeting following the Committee’s meeting. The meeting dates for all Board and Compensation Committee meetings, including the dates for the Compensation Committee to approve the equity grants is set in the fall of the preceding year for the coming year, subject to last minute scheduling conflicts, and is independent of the timing of our disclosure of any material non-public information other than our normal annual earnings release.

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that will enable us to increase dividends for our shareholders. The Compensation Committee generally awards a number of dividend equivalents equal to the number of shares underlying stock options awarded to officers and senior executives each year.

     Each dividend equivalent entitles the grantee to receive in the future an amount of cash compensation equal to the dividends paid by Aqua America on a share of Common Stock for a particular period of time referred to as the accumulation period. For the dividend equivalents awarded to date, the Compensation Committee has set this accumulation period as four years from the date of grant. As part of the dividend equivalent award, the Compensation Committee also sets a target payment date for the amounts accumulated for the dividend equivalents. For the dividend equivalents awarded to date, the Compensation Committee has set this payment date at four years from the date of grant. Under the terms of the Equity Compensation Plan, the actual payment date can be shortened to two years or lengthened to up to eight years depending on our achievement of annual performance criteria established by the Compensation Committee each year. If the payment date is shortened to less than four years, the executive will receive on the payment date any dividend equivalents accrued as of that date and the balance of the applicable dividends on Aqua America’s dividend payment dates through the end of the accumulation period. The performance criteria for determining the payment date consist of achieving our budgeted net income, increasing the dividend paid to shareholders, achieving a total return to shareholders over five years in excess of our peer group as shown in the total return to shareholders graph in the Annual Report to Shareholders and achieving a customer growth target. The performance criteria are the same for all executives that are granted dividend equivalents each year.

     The Compensation Committee has used restricted stock on a selective basis to supplement the option and dividend equivalent awards to achieve target equity incentive levels for certain executives and as a retention tool for selected executives. The Compensation Committee has historically made annual awards of restricted stock to our Chief Executive Officer, primarily as a retention tool. In recent years, the Compensation Committee has also made limited restricted stock grants to other senior executives, also primarily as a retention tool. Restricted stock grants can vest in a given period of time or in increments over a period of years on the anniversaries of the grant date, subject to our achievement of certain performance criteria. These performance criteria require an increase in our annual operating income over previous periods.

     Awards of stock options, dividend equivalents and restricted stock are generally all made on the same grant date. The Compensation Committee bases its equity incentive awards for the executives each year on the competitive levels for these awards as described above and does not consider any increase or decrease in the value of past equity incentive awards in making this decision.

     In considering the number of stock options to be granted in total to all employees each year, the Compensation Committee considers the number of options outstanding and the number of options to be awarded as a percentage of Aqua America’s total shares outstanding. The number of options granted annually to all employees has been less than 1.0% of Aqua America’s total shares outstanding.

     It is our long-standing practice to set the exercise price for stock options equal to the fair market value of Aqua America’s stock on the date of grant and to make the grant date of equity compensation grants (options, dividend equivalents and restricted stock) the date that the Compensation Committee approves the grants. The meeting dates for all Board and Compensation Committee meetings, including the dates for the Compensation Committee to approve the equity grants is set in the fall of the preceding year for the coming year, subject to last minute scheduling conflicts, and is independent of the timing of our disclosure of any material non-public information. The Compensation Committee has historically used the average of the high and low trading prices of our Common Stock on the New York Stock Exchange on the date of grant to determine the fair market value and, therefore, the exercise price of options. Beginning in 2007, the Compensation Committee will use the closing price of our Common Stock on the New York Stock Exchange on the date of grant to determine the exercise price of options granted.

anniversary of the date of grant, and the share grant to Mr. Hugus is subject to a two-year restriction period with the full amount of the grant to be released at the end of the two-year period, subject in each case to the Company’s achievement of performance criteria established by the Committee.

     Section 162(m) of the Internal Revenue Code generally precludes the deduction for federal income tax purposes of more than $1 million in compensation (including long-term incentives) paid to the Chief Executive Officer and the other officers named in the Summary Compensation Table in any one year, subject to certain specified exceptions. While Aqua America’s executive compensation program is structured to be sensitive to the deductibility of compensation for federal income tax purposes, the program is principally designed to motivate senior executives to achieve the Company’s goals. Therefore, the Company has determined that it may be appropriate for the Chief Executive Officer’s compensation to be at a level such that a portion is not deductible for federal income tax purposes. However, no part of the Company’s executive compensation package for 2005 was subject to the limitation on the federal tax deduction for such compensation under Section 162(m).

     The foregoing reports of the Audit Committee and the Executive Compensation and Employee Benefits Committee and the Comparative Stock Performance Chart below shall not be deemed incorporated by reference by any general statement incorporating by reference this proxy statement into any filing under the Securities Act of 1933 or Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates this information by reference, and shall not otherwise be deemed filed under such Acts.

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