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| ARTNA > SEC Filings for ARTNA > Form 10-Q on 7-Nov-2008 | All Recent SEC Filings |
7-Nov-2008
Quarterly Report
RESULTS OF OPERATIONS FOR THE PERIOD ENDED SEPTEMBER 30, 2008
Overview
Strategic Direction
Our profitability is primarily attributable to the sale of water by Artesian Water, the amount of which is dependent on seasonal fluctuations in weather, particularly during the summer months when water demand may vary with rainfall and temperature. In the event that temperatures during the typically warmer months are cooler than expected, or rainfall is greater than expected, the demand for water may decrease and our revenues may be adversely affected. We believe the effects of weather are short term and do not materially affect the execution of our strategic initiatives.
Our initiatives south of the C&D Canal that began in 1992 are now providing the greatest portion of our customer growth. This shift in growth is primarily the result of the build out of our service area in northern New Castle County, Delaware.
While customer growth in our water utility subsidiaries continued to be a major focus in the first nine months of 2008, we aggressively seek opportunities that produce revenue streams that are not as directly affected by weather. These opportunities include the efforts of Artesian Utility, which is actively pursuing opportunities to design, build and operate water and wastewater facilities throughout Delaware and surrounding areas on the Delmarva Peninsula. In addition, Artesian Utility acquired all rights, titles and interest in the operations contracts of TMH. We currently provide contract water and wastewater operation services to 21 private, municipal and governmental institutions in the southeastern part of Pennsylvania. Artesian Wastewater began providing wastewater services to customers in Delaware as a regulated public wastewater service company in July 2005. The opportunities generated through our wastewater service company may provide additional service territory for the regulated water subsidiary or may provide contract operations services for municipalities or other regulated entities. We will continue to focus attention on expanding our contract operations opportunities with municipalities and private water providers on the Delmarva Peninsula.
Our strategy is to focus on total resource management covering a wide spectrum of activities, which include: identifying new and dependable sources of supply; developing the wells, treatment plants and delivery systems to get water to customers; educating customers on the wise use of water; and providing responsible wastewater management to assist with recharge of the aquifers. Our strategy includes focusing our efforts to expand in new regions added to our service territory over the last 10 years, where growth is strong and demand is increasing. We also foresee significant growth opportunities in wastewater service and will continue to seek strategic partnerships and relationships with developers and municipalities to complement existing agreements for the provision of wastewater service on the Delmarva Peninsula.
In addition to services discussed above, Artesian Resources initiated a Water Service Line Protection Plan, or WSLP Plan, in March 2005. The WSLP Plan covers all parts, material and labor required to repair or replace participants' leaking water service lines up to an annual limit. As of September 30, 2008, approximately 11,600, or 19%, of our 60,000 eligible water customers had signed up for the WSLP Plan. The WSLP Plan was expanded in the second quarter of 2008 to include maintenance or repair to customers' sewer lines. This plan, Sewer Service Line Protection Plan, or SSLP Plan, covers all parts, material and labor required to repair or replace participants' leaking or clogged sewer lines up to an annual limit. As of September 30, 2008, approximately 3,400, or 8%, of our 42,800 eligible customers had signed up for the SSLP Plan.
In July 2008, Artesian Wastewater and the Town of Georgetown, or Georgetown, finalized a wastewater service agreement establishing a long term arrangement that will meet the future wastewater treatment and disposal needs in Georgetown's growth and annexation areas. Artesian Wastewater will provide up to 1 million gallons per day of wastewater capacity for the town within the next 10 years. Artesian Wastewater will receive untreated wastewater effluent from properties located within Georgetown's current and future annexation and growth areas. Artesian Wastewater will be responsible for capital improvements required for the treatment, storage and disposal of wastewater effluent from Georgetown's Sand Hill Pump station, as well as design, construction and maintenance of the regional wastewater facility, a force main interconnection, all meters and piping necessary to receive Georgetown's effluent flow. Georgetown will compensate Artesian Wastewater $1 million for a portion of the cost of the regional force main. Georgetown will also pay connection contribution fees in reference to each residential and non-residential structure utilizing the regional wastewater facility.
Regulatory Matters and Inflation
As of September 30, 2008, we had approximately 75,800 metered water customers, approximately 600 wastewater customers, and served a population of approximately 256,000 (including contract services), representing approximately 30% of Delaware's total population. Increases in the number of customers served by Artesian Water and Artesian Wastewater contributed to increases in our operating revenues. The Delaware Public Service Commission, or PSC, regulates both Artesian Water's and Artesian Wastewater's rates charged for service, the sale and issuance of securities and other matters. Artesian Water Maryland is subject to the regulatory jurisdiction of the Maryland Public Service Commission. Artesian Water Pennsylvania is subject to the regulatory jurisdiction of the Pennsylvania Public Utilities Commission.
Our regulated utilities periodically seek rate increases to cover the cost of increased operating expenses, increased financing expenses due to additional investments in utility plant and other costs of doing business. In Delaware, utilities are permitted by law to place rates into effect, under bond, on a temporary basis pending completion of a rate increase proceeding. The first temporary increase may be up to the lesser of $2.5 million on an annual basis or 15% of annual gross water sales. Should the rate case not be completed within seven months, by law, the utility may put the lesser of the entire requested rate relief or 15% of annual gross water sales in effect, under bond, until a final resolution is ordered and placed into effect. If such rates are found to be in excess of rates the PSC finds to be appropriate, we must refund the portion found in excess to customers with interest. The timing of our rate increase requests are therefore dependent upon the estimated cost of the administrative process in relation to the investments and expenses that we hope to recover through the rate increase. We can provide no assurances that rate increase requests will be approved by the applicable regulatory agencies; and, if approved, we cannot guarantee that these rate increases will be granted in a timely or sufficient manner to cover the investments and expenses for which we initially sought the rate increase. On April 22, 2008, Artesian Water filed a petition with the PSC to implement new rates to meet a requested increase in revenue of 28.8%, or approximately $14.2 million, on an annualized basis. On July, 11, 2008, pursuant to the PSC's minimum filing requirements, Artesian filed a supplemental filing with the PSC to update financial schedules for actual experience through March 31, 2008 and to reflect additional changes affecting the requested increase. The overall result was a reduction to the requested increase in revenue of 1.5%, to 27.3% or approximately $13.5 million, on an annualized basis.
As permitted by law, on June 21, 2008, we placed temporary rates into effect, designed to generate an increase in annual operating revenue of approximately 5.0%, or $2.5 million on an annualized basis, until new rates are approved by the PSC. Evidentiary hearings have been set for December 8-10, 2008 and a final Commission decision is anticipated in the first quarter of 2009 in reference to the implementation of our requested rate increase.
In 2003, legislation was enacted in Delaware requiring all water utilities serving within northern New Castle County to certify by July 2006 that they have sufficient sources of self-supply to serve their respective systems. On June 30, 2006, Artesian Water filed our certification related to the adequacy of our water supply through 2009. After completion of their review, on July 24, 2007, the PSC accepted our certification of sufficient water supply.
Delaware statute permits utilities to put into effect on a semi-annual basis, increases related to specific types of distribution system improvements through DSIC. This charge is available to water utilities to be implemented between general rate increase applications that normally recognize changes in a water utility's overall financial position. The DSIC process is less costly when compared to the approval process for general rate increase requests. The DSIC rate applied between base rate filings is capped at 7.5% of the amount billed to customers under otherwise applicable rates and charges, and the DSIC rate increase applied cannot exceed 5% within any 12-month period. In December 2007, Artesian Water filed an application with the PSC for approval to collect a 0.46% increase, effective January 1, 2008, to recover the costs of eligible non-revenue producing improvements made since the last rate increase in 2006. The PSC approved the DSIC effective January 1, 2008 subject to audit at a later date. During the first nine months of 2008, we earned approximately $99,000 in DSIC revenue. On June 21, 2008, the Company discontinued the collection of DSIC pursuant to Delaware law which requires the Company to discontinue a DSIC when new base rates are put into effect. We did not have DSIC in effect during 2007.
On April 10, 2006, the PSC made effective new rules under Regulation Docket 15 that govern the terms and conditions under which water utilities require advances or contributions from customers or developers. These regulations require that developers pay for all water facilities within a new development, with such funding recorded as contributions in aid of construction by the water utility. In addition, the utility is required to receive a contribution in aid of construction of $1,500 for each new residential connection to its system towards the cost of water supply, treatment and storage facilities. These regulations further require developers to fully pay for facilities to serve satellite systems. These required contributions are intended to place a greater burden upon new customers to pay for the cost of facilities required to serve them. On April, 8, 2008, the PSC reopened this docket to assess the effectiveness of the 2006 rules and regulations requiring water utilities to collect contributions in aid of construction. We anticipate this proceeding to continue through the end of the year.
We are affected by inflation, most notably by the continually increasing costs required to maintain, improve and expand our service capability. The cumulative effect of inflation results in significantly higher facility costs compared to investments made 20 to 40 years ago, which must be recovered from future cash flows.
Results of Operations - Analysis of the Quarter Ended September 30, 2008 Compared to the Quarter Ended September 30, 2007
Operating Revenues
Revenues totaled $15.7 million for the quarter ended September 30, 2008, $0.7 million, or 4.1%, above revenues for the quarter ended September 30, 2007 of $15.0 million. Water sales revenues increased 2.7% for the quarter ended September 30, 2008, over the corresponding period in 2007. Water sales revenue for the quarter ended September 30, 2008 was positively impacted by the implementation of the second step of the rate increase on July 24, 2007 of 3.0% as approved by the PSC upon completion of our issuance of common stock and a temporary rate increase of 5% placed into effect on June 21, 2008, as permitted under Delaware law, until new rates are approved by the PSC. However, per capita demand has declined for the quarter ended September 30, 2008 in comparison to the quarter ended September 30, 2007, thereby reducing the effect of the temporary rate increase. We realized 90.9% of our total operating revenue for the quarter ended September 30, 2008 from the sale of water. In 2007, 92.1% of our total revenue was from water sales.
Non-utility operating revenue increased $119,000 for the quarter ended September 30, 2008, or 14.2%, from $836,000 in 2007 to $955,000 in 2008. The increase in revenue is the result of an increase of $78,000 and $64,000 in wastewater and water SLP Plan revenue. The SLP Plan provides coverage for all material and labor required to repair or replace participants' leaking water and leaking or clogged wastewater service lines up to an annual limit. Pennsylvania based contract operations revenue in Artesian Utility increased $35,000 for the quarter ended September 30, 2008 compared to the same period in 2007. These increases were offset by a decrease in design and construction contract revenue for Artesian Utility in the third quarter of 2008 compared to the same quarter a year ago.
Operating Expenses
Operating expenses, excluding depreciation and income taxes, increased $0.6 million, or 8.9%, to $8.4 million for the quarter ended September 30, 2008, compared to $7.8 million for the same period in 2007. The increase in operating expenses is the result of an increase in utility operating expenses of $645,000.
The increase in utility operating expense of $645,000 for the quarter ended September 30, 2008, or 10.1%, over the same period in 2007, is comprised of increases in payroll and employee benefits costs, purchased water and purchased power expense.
Payroll and employee benefit expense increased $248,000, or 7.9%, compared to the same period in 2007, primarily due to increases in employee count, employee wages from merit increases, and increased employee benefit premium expenses.
Purchased water expense increased $229,000, or 35.3%, compared to the same period in 2007, primarily due to the timing of purchases under minimum contracts from the Chester Water Authority and an increase of 7.8% in Chester Water Authority's rates effective in July 2008.
Purchased power expense increased $89,000, or 16.0%, compared to the same period in 2007 due to an 8.47% rate increase in May 2008 under the new two-year electric supply contract and increased usage.
Property and other taxes increased by $41,000, or 5.5%, compared to the same period in 2007, reflecting increases in tax rates charged for public schools in various areas where Artesian holds property and increases in the number of plants owned by Artesian. Property taxes are assessed on land, buildings and certain utility plant, which includes the footage and size of pipe, hydrants and wells primarily owned by Artesian Water.
The ratio of operating expense, excluding depreciation and income taxes, to total revenue was 53.9% for the quarter ended September 30, 2008, compared to 51.6% for the quarter ended September 30, 2007.
Depreciation and amortization expense increased $83,000, or 6.2%, over the quarter ended September 30, 2008 as compared to the same period in 2007, due to continuing investment in utility plant in service providing supply, treatment, storage and distribution of water.
Federal and state income tax expense decreased $56,000 due to lower taxable income for the quarter ended September 30, 2008, compared to the quarter ended September 30, 2007.
Other Income, Net
Our Allowance for Funds Used During Construction, or AFUDC, increased $207,000, or 265.4%, compared to the same period in 2007, as a result of increased long-term construction activity subject to AFUDC for the third quarter of 2008 compared to the same period in 2007.
Interest Charges
Interest charges increased $181,000, or 12.1%, for the quarter ended September 30, 2008, compared to the quarter ended September 30, 2007, primarily due to more short-term debt interest as a result of higher borrowing on our lines of credit in 2008 compared to 2007. The average debt outstanding for the quarter ended September 30, 2008 was $16.6 million at an average rate of 3.8% compared to $0.9 million and an average rate of 6.3% for the same period in 2007.
Net Income
Our net income decreased $170,000, or 6.2%, for the quarter ended September 30, 2008, compared to the same period a year ago. The decrease in net income for the quarter was primarily the result of lower operating income margins from both our water and wastewater utility business which experienced a decline in demand offsetting the rate increases as described above. Increased payroll, purchased water, and purchased power costs added to the decrease in net income as well as higher interest charges. Offsetting this unfavorable variance for the three months ended September 30, 2008 were higher operating income margins from our non-utility business due to increased wastewater and water SLP Plan revenue as well as higher other income from increased construction interest income (AFUDC). Basic earnings per share decreased to $0.35 for the quarter ended September 30, 2008 compared to $0.38 for the same period in 2007. Diluted earnings per share were $0.35 and $0.37 for the quarter ended September 30, 2008 and 2007.
Results of Operations - Analysis of the Nine Months Ended September 30, 2008 Compared to the Nine Months Ended September 30, 2007
Operating Revenues
Revenues totaled $41.8 million for the nine months ended September 30, 2008, $2.2 million, or 5.7%, above revenues for the nine months ended September 30, 2007 of $39.6 million. Water sales revenues increased $1.3 million, 3.6%, for the nine months ended September 30, 2008, over the corresponding period in 2007. Water sales revenue for the nine months ended September 30, 2008 was positively impacted by the implementation of the second step of the rate increase on July 24, 2007 of 3.0% as approved by the PSC upon completion of our issuance of common stock and a temporary rate increase of 5% placed into effect on June 21, 2008, as permitted under Delaware law, until new rates are approved by the PSC. However, per capita demand has declined for the nine months ended September 30, 2008 in comparison to the nine months ended September 30, 2007, thereby reducing the effect of the temporary rate increase. We realized 90.4% of our total operating revenue for the nine months ended September 30, 2008 from the sale of water. In 2007, 92.3% of our total revenue was from water sales.
Other utility operating revenue increased $210,000 for the nine months ended September 30, 2008, or 16.6%, from $1.3 million in 2007 to $1.5 million for the same period in 2008. Approximately $190,000 of this increase was primarily due to service charges for the restoration of shut off service.
Non-utility operating revenue increased $733,000 for the nine months ended September 30, 2008, or 40.7%, from $1,799,000 in 2007 to $2,532,000 in 2008. This increase is attributable to increased contract revenues in Artesian Utility, primarily due to design and permitting services totaling $250,000 performed for a developer in Sussex County, Delaware and the addition of Pennsylvania contract operations of $232,000. The increase in revenue also includes an increase of $146,000 and $82,000, respectively, for the water and wastewater SLP Plan revenue. The SLP Plan provides coverage for all material and labor required to repair or replace participants' leaking water and leaking or clogged wastewater service lines up to an annual limit.
Operating Expenses
Operating expenses, excluding depreciation and income taxes, increased $2.4 million, or 10.7%, to $25.4 million for the nine months ended September 30, 2008, compared to $23.0 million for the same period in 2007. The components of the increase in operating expenses included an increase in utility operating expenses of $1,656,000 and an increase in property taxes of $250,000. Non-utility operating expenses increased $549,000 in the first nine months of 2008, or 45.1%, compared to the same period last year.
The increase in utility operating expense of $1,656,000 for the nine months ended September 30, 2008, or 8.4%, over the same period in 2007, is comprised of increases in payroll and employee benefits costs, purchased water, and purchased power expense.
Payroll and employee benefit expense increased $789,000, or 8.0%, compared to the same period in 2007, primarily due to increases in employee count, employee wages from merit increases, and increased employee benefit premium expense.
Purchased water expense increased $448,000, or 23.5%, compared to the same period in 2007, primarily due to the timing of purchases under minimum contracts from Chester Water Authority and an increase in Chester Water Authority's rates of 7.8% effective in July 2008.
Purchased power expense increased $186,000, or 10.7%, compared to the same period in 2007 due to an 8.47% rate increase in May 2008 under the new two-year electric supply contract and increased usage.
Non-utility expense increased approximately $549,000, or 45.1%, for the nine months ended September 30, 2008, compared to the nine months ended September 30, 2007, as a result of increased contract projects as compared to the same period in 2007.
Property and other taxes increased by $250,000, or 11.7%, compared to the same period in 2007, reflecting increases in tax rates charged for public schools in various areas where Artesian holds property and increases in the number of plants owned by Artesian. Property taxes are assessed on land, buildings and certain utility plant, which includes the footage and size of pipe, hydrants and wells primarily owned by Artesian Water.
The ratio of operating expense, excluding depreciation and income taxes, to total revenue was 60.8% for the nine months ended September 30, 2008, compared to 58.1% for the nine months ended September 30, 2007.
Depreciation and amortization expense increased $220,000, or 5.7%, over the nine months ended September 30, 2008 as compared to the same period in 2007, due to continuing investment in utility plant in service providing supply, treatment, storage and distribution of water.
Other Income, Net
Our Allowance for Funds Used During Construction, or AFUDC, increased $402,000, or 188.7%, compared to the same period in 2007, as a result of increased long-term construction activity subject to AFUDC for the nine months ended September 30, 2008, compared to the same period in 2007.
Interest Charges
Interest charges decreased $46,000, or 1.0%, for the nine months ended September 30, 2008, compared to the nine months ended September 30, 2007, primarily due to less short-term debt interest as a result of lower borrowing on our lines of credit coupled with lower average borrowing costs in 2008 compared to 2007.
Net Income
Our net income decreased $69,000, or 1.3%, for the nine months ended September 30, 2008, compared to the same period a year ago. The decrease in net income for the nine months was primarily the result of lower operating income margins from both our water and wastewater utility business which experienced a decline in demand offsetting the rate increases as described above. Increased payroll, purchased water, and purchased power costs added to the decrease in net income. Offsetting this unfavorable variance for the nine months ended September 30, 2008 were higher operating income margins from our non-utility business due to increased wastewater and water SLP Plan revenue, higher other income from increased construction interest income (AFUDC), and lower short-term interest charges for the nine months compared to the same period a year ago. Basic earnings per share decreased to $0.70 for the year ended September 30, 2008 compared to $0.78 for the same period in 2007. Diluted earnings per share were $0.69 and $0.77 for the year ended September 30, 2008 and 2007.
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of liquidity for the nine months ended September 30, 2008 were $14.8 million provided by cash flow from operating activities, $2.0 million in net contributions and advances from developers and $26.0 million in net borrowings on our lines of credit. Cash flow from operating activities is primarily provided by our utility operations, and is impacted by the timeliness and adequacy of rate increases and changes in water consumption as a result of year-to-year variations in weather conditions particularly during the summer. A significant part of our ability to maintain and meet our financial objectives is to assure our investments in utility plant and equipment are recovered in the rates charged to customers. As such, from time to time we file rate increase requests to recover increases in operating expenses and investments in utility plant and equipment.
The Company's lines of credit have increased by $26 million primarily as a result of investments made in utility plant detailed below and the $6.6 million investment made in non-utility property associated with a new regional wastewater facility in Sussex County, Delaware. In addition, increases in accounts payable of $1.7 million and increases in accrued expenses of $1.8 million are also associated with the Company's investment in utility plant.
We invested $41.7 million in capital expenditures during the first nine months of 2008, which includes $2.0 million of net advances and contribution in aid of construction, compared to $18.6 million invested during the same period in 2007. The primary focus of Artesian Water's investment was to continue to provide high quality reliable service to our growing service territory. We have invested $6.2 million through the nine months ended September 30, 2008, for the construction of new treatment facilities, to enhance or improve existing treatment facilities, and for the rehabilitation of pumping equipment to better serve our customers. In addition, we are continuing our regional approach to building infrastructure through connecting existing supply infrastructure to new developments and at the same time providing redundancy to existing developments by connecting them to the regional system. These efforts resulted in an investment of $11.3 million in the first nine months of 2008. Artesian invested $12.3 million in general plant in the first nine months of 2008. This included $9.9 million towards the construction of a new office building addition to our corporate headquarters in New Castle County. Another $6.6 million was invested into NSRWRC for the land and construction in progress of the regional wastewater treatment facility. In addition, on August 1, 2008 Artesian Water Maryland invested $4.8 million for the acquisition of Mountain Hill.
At September 30, 2008, Artesian Water and Artesian Water Maryland had two shared lines of credit of $20 million each to meet temporary cash requirements. These revolving credit facilities are unsecured. As of September 30, 2008, we had . . .
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