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ARTNA > SEC Filings for ARTNA > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for ARTESIAN RESOURCES CORP

Form 10-Q for ARTESIAN RESOURCES CORP


7-Nov-2012

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS FOR THE PERIOD ENDED SEPTEMBER 30, 2012

OVERVIEW

Our profitability is primarily attributable to the sale of water by Artesian Water. Gross water sales in Artesian Water comprise 88.4% of total operating revenues. Our profitability is also attributed to the various contract operations, water and sewer Service Line Protection Plans and other services we provide. Water sales are subject to seasonal fluctuations, particularly during summer when water demand may vary with rainfall and temperature. In the event 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 contract operations and other services provide a revenue stream that is not affected by changes in weather patterns.

While water sales revenues are our primary source of revenues, we continue to seek growth opportunities to provide wastewater service in Delaware and the surrounding areas. We also continue to explore and develop relationships with developers and municipalities in order to increase revenues from contract water and wastewater operations, wastewater management services, design, construction and engineering services. We plan to continue developing and expanding our contract operations and other services in a manner that complements our growth in water service to new customers. Our anticipated growth in these areas is subject to changes in residential and commercial construction, which may be affected by interest rates, inflation and general housing and economic market conditions. We anticipate continued growth in our non-regulated division due to our water and sewer Service Line Protection Plans.

Water Division

Artesian Water, Artesian Water Maryland and Artesian Water Pennsylvania provide water service to residential, commercial, industrial, governmental, municipal and utility customers. Increases in the number of customers served contributed to increases in our operating revenue. The Town of Middletown, which is one of our municipal customers and is located in southern New Castle County, Delaware, has nearly doubled in population since 2001, and population growth in this area is expected to continue for some time as a result of ongoing and future residential construction. As population growth continues in Middletown and other areas in Delaware, we believe that the demand for water will increase, thereby contributing to an increase in our operating revenues. As of September 30, 2012, we had approximately 78,900 metered water customers in Delaware, an increase of approximately 400 compared to September 30, 2011. The number of metered water customers in Maryland increased by approximately 1,500 compared to 2011 following the purchase of the Cecil County assets and the number of metered water customers in Pennsylvania remained consistent with 2011. For the nine months ended September 30, 2012, approximately 5.7 billion gallons of water was distributed in our Delaware systems and approximately 0.1 billion gallons of water was distributed in our Maryland systems.

Wastewater Division

Artesian Wastewater owns wastewater infrastructure and began providing wastewater services in Delaware in July 2005. Artesian Wastewater Maryland was incorporated on June 3, 2008 to provide regulated wastewater services in Maryland. Our wastewater customers are billed a flat monthly fee, which contributes to providing a revenue stream unaffected by weather.

On September 27, 2011, Artesian Resources, Artesian Wastewater Maryland and Cecil County mutually agreed to enter into a Termination of Asset Purchase Agreements, Franchise and Parent Guaranty, or the Termination Agreement, to terminate two purchase agreements, or the Asset Purchase Agreements, relating to the Meadowview Wastewater Facility, Highlands Wastewater Facility, Cherry Hill Wastewater Facility and the Harbourview Wastewater Facility, and related real property, easement rights and wastewater collection systems with respect to each facility or the wastewater facilities. Certain ancillary agreements, including a wastewater franchise agreement between Artesian Wastewater Maryland and Cecil County, and a parent guaranty between Artesian Resources and Cecil County, were also terminated by the Termination Agreement. Termination of the wastewater franchise agreement was approved by the MDPSC on April 18, 2012.


Table of Contents

Non-Regulated Division

Artesian Utility provides contract water and wastewater operation services to private, municipal and governmental institutions. Artesian Utility currently operates wastewater treatment facilities for the town of Middletown, in southern New Castle County, or Middletown, under a 20-year contract that expires on February 1, 2021. The facilities include two wastewater treatment stations with capacities of up to approximately 2.5 mgd and 250,000 gallons per day, respectively. We also operate a wastewater disposal facility in Middletown in order to support the 2.5 mgd wastewater facility.

One of the wastewater treatment facilities in Middletown now provides reclaimed wastewater for use in spray irrigation on public and agricultural lands in the area. Our relationship with the Town of Middletown has given us the opportunity to create the Artesian Water Resource Management Partnership, or AWRMP, to encourage and support the use of reclaimed water for agricultural irrigation and other needs. Using reclaimed water to irrigate farm fields can save the Delmarva region millions of gallons of groundwater each day. The AWRMP's first project in Middletown will save up to three million gallons of water per day during the peak growing season. Through the AWRMP initiative, Artesian will provide planning, engineering and technical expertise and help bring together the various state, local and private partners needed for water recycling project approvals.

Artesian Utility currently operates the WSLP Plan and the SSLP Plan, effective April 2012. Artesian Resources initiated the WSLP Plan in March 2005. The WSLP Plan covers all parts, material and labor required to repair or replace participating customers' leaking water service lines up to an annual limit. The WSLP Plan was expanded in the second quarter of 2008 to include maintenance or repair to customers' sewer lines. The SSLP Plan covers all parts, material and labor required to repair or replace participating customers' leaking or clogged sewer lines up to an annual limit. Also, in the second quarter of 2010, the WSLP Plan and SSLP Plan were extended to include non-customers of Artesian Resources. As of September 30, 2012, approximately 17,300, or 25.1%, of our eligible water customers signed up for the WSLP Plan, approximately 10,000, or 14.7%, of our eligible customers signed up for the SSLP Plan and approximately 900 non-customer participants signed up for either the WSLP Plan or SSLP Plan.

Artesian Development is a real estate holding company that owns properties, including land zoned for office buildings, a water treatment plant and wastewater facility, as well as property for current operations, including an office facility in Sussex County, Delaware. The facility consists of approximately 10,000 square feet of office space along with nearly 10,000 square feet of warehouse space. This facility allows all of our Sussex County, Delaware operations to be housed in one central location.

Artesian Consulting Engineers acquired all the assets of Meridian Architects and Engineers in June 2008. As a result of the decline in new housing and development due to the economic downturn, the need for development and architectural services has remained depressed. Therefore, in April 2011, we decided to reduce staffing levels and reorganize the business. Artesian Consulting Engineers no longer provides development and architectural services to outside third parties. Artesian Consulting Engineers will continue to work with existing clients on projects already in progress for engineering services until those projects are complete. We will continue to provide design and engineering contract services through our Artesian Utility subsidiary.

Strategic Direction

Our strategy is to significantly increase customer growth, revenues, earnings and dividends by expanding our water, wastewater and Service Line Protection Plan services across the Delmarva Peninsula. We remain focused on providing superior service to our customers and continuously seeking ways to improve our efficiency and performance. By providing water and wastewater services, we believe we are positioned as the primary resource for developers and communities throughout the Delmarva Peninsula seeking to fill both needs simultaneously. We have a proven ability to acquire and integrate high growth, reputable entities, through which we have captured additional service territories that will serve as a base for future revenue. With respect to recent acquisitions, we have successfully integrated their operations, infrastructure, technology and employees. We believe this experience presents a strong platform for further expansion and that our success to date also produces positive relationships and credibility with regulators, municipalities, developers and customers in both existing and prospective service areas.


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In our regulated water division, our strategy is to focus on a wide spectrum of activities, which include identifying new and dependable sources of supply, developing the wells, treatment plants and delivery systems to supply water to customers and educating customers on the wise use of water. Our strategy includes focused efforts to expand in new regions added to our Delaware service territory over the last 10 years. In addition, we believe growth will occur in the Maryland counties on the Delmarva Peninsula. We plan to expand our regulated water service area in the Cecil County designated growth corridor and to expand our business through the design, construction, operation, management and acquisition of additional water systems. The expansion of our exclusive franchise areas elsewhere in Maryland and the award of additional contracts will similarly enhance our operations within the state.

We believe that Delaware's generally lower cost of living in the region, availability of development sites in relatively close proximity to the Atlantic Ocean in Sussex County, and attractive financing rates for construction and mortgages have resulted, and will continue to result, in increases to our customer base. Delaware's lower property and income tax rate make it an attractive region for new home development and retirement communities. Substantial portions of Delaware are currently not served by a public water system, which could also assist in an increase to our customer base as systems are added.

In our regulated wastewater division, we foresee significant growth opportunities 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. Artesian Wastewater completed an agreement with Georgetown, Delaware in July 2008 to provide wastewater treatment and disposal services for Georgetown's growth and annexation areas. Artesian Wastewater will provide up to 1 mgd of wastewater capacity for the town. The preliminary engineering and design work was completed on a regional wastewater treatment and disposal facility located in the northern Sussex County area that has the potential to treat up to approximately 8 mgd. This facility is strategically situated on 75 acres to provide service to the growing population in the Georgetown, Ellendale and Milton areas, as well as to neighboring municipal systems. This facility was granted conditional use approval by Sussex County Council to serve the Elizabethtown subdivision of approximately 4,000 homes and 439,000 square feet of proposed commercial space, as well as seven additional projects comprising approximately 3,000 residential units. The facility will also be capable of offering wastewater services to local municipalities. Artesian Wastewater will manage the design and construction of the facility and, once constructed, the operation of the facility.

The general need for increased capital investment in our water and wastewater systems is due to a combination of population growth, more protective water quality standards and aging infrastructure. Our capital investment plan for the next five years includes projects for water treatment plant improvements and additions in both Delaware and Maryland and wastewater treatment plant improvements and additions in Delaware. Capital improvements are planned and budgeted to meet anticipated changes in regulations and needs for increased capacity related to projected growth. The Delaware Public Service Commission and Maryland Public Service Commission have generally recognized the operating and capital costs associated with these improvements in setting water and wastewater rates for current customers and capacity charges for new customers.

In our non-regulated division, we are actively pursuing opportunities to expand our contract operations. Through Artesian Utility, we will seek to expand our contract design and construction services of water and wastewater facilities for developers, municipalities and other utilities. Artesian Development owns two nine-acre parcels of land, located in Sussex County, Delaware, which will allow for construction of a water treatment facility and wastewater treatment facility. Artesian Consulting Engineers no longer provides development and architectural services to outside third parties. Artesian Consulting Engineers will continue to work with existing clients on projects already in progress for engineering services until those projects are complete. Artesian will continue to provide design and engineering contract services through our Artesian Utility subsidiary.

Regulatory Matters and Inflation

Our water and wastewater utility operations are subject to regulation by their respective state regulatory commissions, which have broad administrative power and authority to regulate rates charged for service, determine franchise areas and conditions of service, approve acquisitions, authorize the issuance of securities and oversee other matters. The profitability of our utility operations is influenced, to a great extent, by the timeliness and adequacy of rate allowances we are granted by the respective regulatory commissions or authorities in the states in which we operate.


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Artesian Water, the DEPSC, and the Division of the Public Advocate entered into an agreement to settle Artesian Water's April 2011 application for an increase in rates. PSC Order No. 8097, issued on January 31, 2012, approved the settlement agreement, authorizing a permanent rate increase in revenue of approximately 11.13%, or $6.25 million on an annualized basis. Since the permanent rate increase did not exceed amounts already collected under previously approved temporary increases in rates, Artesian Water was not required to refund any amounts to its customers. The approved permanent rate increase was effective as of January 1, 2012. The settlement also authorized a return on equity of 10%. Additionally, effective January 1, 2012, the settlement agreement permitted a tariff change that includes the use of a seasonal connection charge as well as a new approach for presenting the cost of retired property and ratemaking treatment for salvage costs to be recovered in rates. Previously, when depreciable units of utility plant were retired, the cost of retired property, together with any cost associated with retirement less any salvage value or proceeds received, was charged to accumulated depreciation. Under the settlement agreement, effective January 1, 2012, any cost associated with retirement less any salvage value or proceeds received is charged to a regulated retirement liability. This new approach resulted in an approximately $1.2 million reclassification of accumulated depreciation of utility plant to deferred credits and other liabilities on our Condensed Consolidated Balance Sheet as of September 30, 2012. The settlement also authorized Artesian Water to change from quarterly to monthly billing, which was implemented in April 2012.

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 Three Months Ended September 30, 2012 Compared to the Three Months Ended September 30, 2011

Operating Revenues

Revenues totaled $19.0 million for the three months ended September 30, 2012, $1.3 million, or 7.2%, above revenues for the three months ended September 30, 2011 of $17.7 million. Water sales revenues increased $1.4 million, or 9.0%, for the three months ended September 30, 2012 over the corresponding period in 2011. Water sales revenue increased primarily due to an 11.13% permanent increase in rates effective January 1, 2012. The permanent rate increase equals the combined temporary rate increases that were placed into effect on June 10, 2011 and November 11, 2011 of 4.45% and 6.68%, respectively. In addition, water sales revenue increased due to the addition of customers and increased water consumption in Cecil County, Maryland. We realized 91.3% of our total operating revenue for the three months ended September 30, 2012 from the sale of water as compared to 89.8% for the three months ended September 30, 2011.

Non-utility operating revenue decreased $0.1 million, or 12.2%, for the three months ended September 30, 2012, from $1.1 million in 2011 to $1.0 million for the same period in 2012. This decrease is primarily due to an approximately $0.2 million decrease in Artesian Utility revenue, related to a decrease in design and permitting services performed and a decrease in contract services performed for municipalities in Maryland following the purchase of the Cecil County water assets. The decrease in non-utility operating revenue is partially offset by an approximately $0.1 million increase in water and wastewater Service Line Protection Plan, or SLP Plans, revenue. The SLP Plans provide coverage for all material and labor required to repair or replace participants' leaking water service or clogged sewer lines up to an annual limit.

Operating Expenses

Operating expenses, excluding depreciation and income taxes, increased $0.6 million, or 6.9%, for the three months ended September 30, 2012, compared to the same period in 2011. The components of the change in operating expenses include an increase in utility operating expenses of $0.8 million and a decrease in non-utility operating expenses of $0.2 million.

The increase in utility operating expenses of $0.8 million, or 10.1%, for the three months ended September 30, 2012 over the same period in 2011, was primarily due to increased wages and medical benefit premiums.

Non-utility expenses decreased approximately $0.2 million, or 27.4%, primarily the result of decreased project activity in Artesian Utility as compared to the same period in 2011.

The ratio of operating expense, excluding depreciation and income taxes, to total revenue was 56.0% for the three months ended September 30, 2012, compared to 56.2% for the three months ended September 30, 2011.


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Depreciation and amortization expense increased $60,000, or 3.2%, primarily due to continued investment in utility plant in service providing supply, treatment, storage and distribution of water.

Federal and state income tax expense increased $399,000 primarily due to higher pre-tax income for the three months ended September 30, 2012, compared to the three months ended September 30, 2011.

Other Income (Expense), Net

Miscellaneous income increased approximately $351,000 primarily due to an approximately $349,000 reclassification of deferred acquisition costs from regulatory assets on our 2011 Condensed Consolidated Balance Sheet to miscellaneous other income (expense) on our 2011 Condensed Consolidated Statement of Income, as a result of the termination of agreements discussed in Note 1 to the 2011 Condensed Consolidated Financial Statements contained in Item 1 to Form 10-Q filed on November 8, 2011 under the heading "General - Maryland Regulated Subsidiaries."

Interest Charges

Interest charges decreased $63,000, or 3.5%, primarily due to a decrease in short-term debt outstanding. We used the proceeds from our July 2011 and August 2011 offering of common stock to repay short-term borrowings.

Net Income

Our net income applicable to common stock increased $0.6 million for the three months ended September 30, 2012, compared to the same period a year ago. This increase in net income was primarily due to higher operating income margins in our water utility business, primarily the result of increased water sales revenue.

Results of Operations - Analysis of the Nine Months Ended September 30, 2012 Compared to the Nine Months Ended September 30, 2011

Operating Revenues

Revenues totaled $53.6 million for the nine months ended September 30, 2012, $4.6 million, or 9.4%, above revenues for the nine months ended September 30, 2011 of $49.0 million. Water sales revenues increased $5.1 million, or 11.7%, for the nine months ended September 30, 2012 over the corresponding period in 2011. Water sales revenue increased primarily due to an 11.13% permanent increase in rates effective January 1, 2012. The permanent rate increase equals the combined temporary rate increases that were placed into effect on June 10, 2011 and November 11, 2011 of 4.45% and 6.68%, respectively. In addition, water sales revenue increased due to the addition of customers and increased water consumption in Cecil County, Maryland. We realized 90.7% of our total operating revenue for the nine months ended September 30, 2012 from the sale of water as compared to 88.8% for the nine months ended September 30, 2011.

Non-utility operating revenue decreased $0.4 million, or 12.9%, for the nine months ended September 30, 2012, from $3.2 million in 2011 to $2.8 million for the same period in 2012. This decrease is primarily due to an approximately $0.5 million decrease in Artesian Utility revenue, related to a decrease in design and permitting services performed and a decrease in contract services performed for municipalities in Maryland following the purchase of the Cecil County water assets. In addition, consulting revenue earned by Artesian Consulting Engineers decreased approximately $0.1 million due to the reduction and reorganization of the business. The decrease in non-utility operating revenue is partially offset by an approximately $0.2 million increase in water and wastewater Service Line Protection Plan, or SLP Plans, revenue. The SLP Plans provide coverage for all material and labor required to repair or replace participants' leaking water service or clogged sewer lines up to an annual limit.

Operating Expenses

Operating expenses, excluding depreciation and income taxes, increased $0.1 million, or 0.3%, to $29.9 million for the nine months ended September 30, 2012, compared to $29.8 million for the same period in 2011. The components of the change in operating expenses include an increase in utility operating expenses of $0.8 million, partially offset by a decrease in non-utility operating expenses.


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The increase in utility operating expenses of $0.8 million, or 3.5%, for the nine months ended September 30, 2012 over the same period in 2011 is primarily due to an increase in payroll and benefit expenses and repair and maintenance expenses, partially offset by a decrease in administration expenses and electric purchased power expenses.

Payroll and benefit expenses increased approximately $1.0 million, or 8.2%, primarily due to increased wages and medical benefit premiums.

Repair and maintenance expenses increased approximately $0.1 million, or 6.2%, primarily due to increased water treatment equipment maintenance costs and increased software support fees.

Administration expenses decreased $0.1 million, or 4.0%, primarily due to reduced legal costs associated with the litigation against Chester Water Authority.

Electric purchased power expenses decreased $0.2 million, or 9.9%, primarily due to the signing of a two-year supply contract at a fixed price. The contract was renewed at a lower fixed price which continues to mitigate future significant increases in electric purchased power expenses. Our most recent supply contract was effective May 2011.

Non-utility expenses decreased approximately $0.8 million, or 35.5%, primarily the result of decreased project activity in Artesian Utility, as compared to the same period in 2011. The decrease in non-utility expenses is also due to a decrease in legal costs of approximately $0.2 million related to the federal grand jury subpoena associated with an investigation that was previously conducted by the United States Attorney's Office in the Eastern District of Pennsylvania and the Environmental Protection Agency.

The ratio of operating expense, excluding depreciation and income taxes, to total revenue was 55.8% for the nine months ended September 30, 2012, compared to 60.9% for the nine months ended September 30, 2011.

Depreciation and amortization expense increased $0.3 million, or 6.3%, primarily due to continued investment in utility plant in service providing supply, treatment, storage and distribution of water.

Federal and state income tax expense increased $2.0 million primarily due to higher pre-tax income for the nine months ended September 30, 2012, compared to the nine months ended September 30, 2011.

Other Income (Expense), Net

Miscellaneous income increased approximately $563,000 primarily due to an approximately $349,000 reclassification of deferred acquisition costs from regulatory assets on our 2011 Condensed Consolidated Balance Sheet to miscellaneous other income (expense) on our 2011 Condensed Consolidated Statement of Income, as a result of the termination of agreements discussed in Note 1 to the 2011 Condensed Consolidated Financial Statements contained in Item 1 to Form 10-Q filed on November 8, 2011 under the heading "General - Maryland Regulated Subsidiaries." In addition, miscellaneous income increased due to an approximately $168,000 refund of assessment payments previously paid to the Delaware Public Service Commission, or DEPSC. Each year public utility companies, like Artesian Water, are required to fund the DEPSC's operations by paying an assessment based on their estimated annual gross revenues. After periodic review by the DEPSC, excess funds above those necessary to operate the DEPSC are refunded to the respective public utility company. The amount refunded to Artesian in 2012 reflects an assessment that covers a 4 year period from 2007 to 2010. The DEPSC is currently analyzing the funding from 2011 forward. Refunds from the DEPSC related to excess fund payments are not typical and we can make no assurances that refunds for excess payments will be issued in the future.

Interest Charges

Interest charges decreased $220,000, or 4.0%, primarily due to a decrease in short-term debt outstanding. We used the proceeds from our July 2011 and August 2011 offering of common stock to repay short-term borrowings.

Net Income

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