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ARTNA > SEC Filings for ARTNA > Form 10-Q on 7-Nov-2013All Recent SEC Filings

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Form 10-Q for ARTESIAN RESOURCES CORP


7-Nov-2013

Quarterly Report


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

RESULTS OF OPERATIONS FOR THE PERIOD ENDED SEPTEMBER 30, 2013

OVERVIEW

Our profitability is primarily attributable to the sale of water. Gross water sales comprise 90.1% of total operating revenues for the nine months ended September 30, 2013. 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 contribute to increases, or help to offset any intermittent decreases 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, 2013, we had approximately 79,400 metered water customers in Delaware, an increase of approximately 500 compared to September 30, 2012. The number of metered water customers in Maryland increased by approximately 200 compared to 2012 following the purchase of the CECO Utilities assets. The number of metered water customers in Pennsylvania remained consistent with 2012. For the nine months ended September 30, 2013, approximately 5.5 billion gallons of water were distributed in our Delaware systems and approximately 245.8 million gallons of water were 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, which was incorporated on June 3, 2008, is able 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.


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 in July 2022. 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 saves 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 operates the WSLP Plan and the SSLP Plan. 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-utility customers of Artesian Resources. As of September 30, 2013, approximately 18,100, or 25.3%, of our eligible water customers signed up for the WSLP Plan, approximately 12,000, or 16.7%, of our eligible customers signed up for the SSLP Plan and approximately 1,000 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 no longer offers development and architectural services to outside third parties. However, Artesian Consulting Engineers continues to work with existing clients on outstanding projects for engineering services until those projects are complete. Artesian 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. 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.


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 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 continue pursuing opportunities to expand our contract operations. Through Artesian Utility, we will seek to expand our contract design, engineering 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.


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.

On January 18, 2013, Artesian Wastewater filed an application with the DEPSC to revise its rates and charges for wastewater services concerning territories located in Kent and Sussex County, Delaware. Artesian Wastewater requested authorization to implement proposed rates for wastewater services to meet a requested increase in revenue of approximately $343,000, or 34.8%, on an annualized basis. The new rates are designed to support Artesian Wastewater's ongoing capital improvement program and to cover increased costs of operations.
On August 6, 2013, Artesian Wastewater, the Staff of the Delaware Public Service Commission and the Division of the Public Advocate entered into an agreement to settle Artesian Wastewater's application for an increase in rates.
On October 8, 2013, the DEPSC approved the settlement agreement authorizing a two-step increase in rates, with the first step effective upon approval of the settlement and the second step effective one year thereafter. Once fully implemented, based on the current number of households, the new rates will provide Artesian Wastewater approximately $174,000 in additional annual revenue. The settlement also authorized a return on equity of 10%.

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, 2013 Compared to the Three Months Ended September 30, 2012

Operating Revenues

Revenues totaled $18.1 million for the three months ended September 30, 2013, $0.9 million, or 4.9%, below revenues for the three months ended September 30, 2012 of $19.0 million. Water sales revenues decreased $1.0 million, or 6.0%, for the three months ended September 30, 2013 from the corresponding period in 2012. A decrease in overall water consumption, a result of the effects of weather associated with the heavy precipitation experienced during the third quarter of 2013, reduced water sales revenues by $1.3 million for the three months ended September 30, 2013 as compared to the same period in 2012.
Partially offsetting this decrease in water sales revenues was an increase in the Distribution System Improvement Charge, or DSIC, revenue of approximately $0.3 million for the three months ended September 30, 2013 compared to the same period in 2012. We realized 90.3% of our total operating revenue for the three months ended September 30, 2013 from the sale of water as compared to 91.3% for the three months ended September 30, 2012.

Non-utility operating revenue increased approximately $97,000, or 10.4%, for the three months ended September 30, 2013 compared to same period in 2012. The increase is primarily due to an approximately $75,000 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, decreased $0.7 million, or 6.6%, for the three months ended September 30, 2013, compared to the same period in 2012. The component of the change in operating expenses includes a decrease in utility operating expenses of $0.7 million.

The decrease in utility operating expenses of $0.7 million, or 8.1%, for the three months ended September 30, 2013 over the same period in 2012, is primarily comprised of a decrease in payroll and employee benefit costs and repair and maintenance costs.

Payroll and employee benefit costs decreased $0.5 million, or 10.7%, primarily the result of bonuses issued to employees in the third quarter of 2012 not issued in 2013.

Repair and maintenance costs decreased $0.1 million, or 13.6%, primarily due to decreased water treatment equipment maintenance costs and decreased water distribution main repair costs.

The ratio of operating expense, excluding depreciation and income taxes, to total revenue was 55.0% for the three months ended September 30, 2013, compared to 56.0% for the three months ended September 30, 2012.

Depreciation and amortization expense increased $109,000, or 5.6%, primarily due to continued investment in utility plant in service providing supply, treatment, storage and distribution of water.

Federal and state income tax expense decreased $164,000, primarily due to lower pre-tax income for the three months ended September 30, 2013, compared to the three months ended September 30, 2012.

Net Income

Our net income applicable to common stock decreased $0.2 million for the three months ended September 30, 2013, compared to the same period a year ago. This decrease in net income was due to lower operating income margins in our water utility business, primarily due to decreased water sales revenue, which was a result of the effects of weather associated with the increased rainfall experienced during the third quarter of 2013.


Results of Operations - Analysis of the Nine Months Ended September 30, 2013 Compared to the Nine Months Ended September 30, 2012

Operating Revenues

Revenues totaled $52.2 million for the nine months ended September 30, 2013, $1.4 million, or 2.7%, below revenues for the nine months ended September 30, 2012 of $53.6 million. Water sales revenues decreased $1.6 million, or 3.3%, for the nine months ended September 30, 2013 from the corresponding period in 2012. A decrease in overall water consumption, a result of the effects of weather associated with the heavy precipitation experienced during 2013, reduced water sales revenues by $2.4 million for the nine months ended September 30, 2013 as compared to the same period in 2012. Partially offsetting this decrease in water sales revenues was an increase in the Distribution System Improvement Charge, or DSIC, revenue of approximately $0.8 million for the nine months ended September 30, 2013 compared to the same period in 2012. We realized 90.1% of our total operating revenue for the nine months ended September 30, 2013 from the sale of water as compared to 90.7% for the nine months ended September 30, 2012.

Other utility operating revenue increased approximately $54,000, or 2.5%, for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. The increase is primarily due to an increase in wastewater revenue.

Non-utility operating revenue increased approximately $111,000, or 3.9%, for the nine months ended September 30, 2013 compared to same period in 2012. The increase is primarily due to an approximately $193,000 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. The increase in non-utility operating revenue is partially offset by an approximately $91,000 decrease in Artesian Utility revenue, related to a decrease in contract services performed for municipalities in Maryland and a decrease in design services.

Operating Expenses

Operating expenses, excluding depreciation and income taxes, increased $0.4 million, or 1.2%, for the nine months ended September 30, 2013, compared to the same period in 2012. The primary components of the change in operating expenses includes an increase in utility operating expenses of $0.2 million and an increase in property and other taxes of $0.1 million.

The increase in utility operating expenses of $0.2 million, or 0.9%, for the nine months ended September 30, 2013 over the same period in 2012, is primarily comprised of an increase in administration expenses, partially offset by a decrease in payroll and employee benefit costs and repair and maintenance expenses.

Administration expenses increased $0.6 million, or 17.1%, primarily due to increased legal costs associated with the litigation against Chester Water Authority in regard to the proper determination of the rate charged for water purchased under contract from the Chester Water Authority and increased consulting services related to the upgrade of our customer service software.

Payroll and employee benefit costs decreased $0.3 million, or 2.3%, primarily the result of bonuses issued to employees in 2012 not issued in 2013 partially offset by an increase in medical benefit premiums and an increase in wages.


Repair and maintenance expenses decreased approximately $0.1 million, or 2.6%, primarily due to decreased water treatment equipment maintenance costs.

Property and other taxes increased by $89,000, or 3.0%, reflecting increases in tax rates charged for public schools in various areas where Artesian holds property and an increase in utility plant subject to taxation. Property taxes are assessed on land, buildings and certain utility plant, which include 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 58.0% for the nine months ended September 30, 2013, compared to 55.8% for the nine months ended September 30, 2012.

Depreciation and amortization expense increased $0.3 million, or 4.8%, primarily due to continued investment in utility plant in service providing supply, treatment, storage and distribution of water.

Federal and state income tax expense decreased $0.9 million, primarily due to lower pre-tax income for the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012.

Other Income, Net

Miscellaneous income decreased $153,000 primarily due to a refund of assessment payments previously paid to the Delaware Public Service Commission, or DEPSC, received in 2012. 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 amount refunded to Artesian in 2013 reflects an assessment that covers 2011. 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.

Net Income

Our net income applicable to common stock decreased $1.3 million for the nine months ended September 30, 2013, compared to the same period a year ago. This decrease in net income was due to lower operating income margins in our water utility business, primarily the result of decreased water sales revenue. The decreased water sales revenue is primarily due to a decrease in overall water consumption, which is the result of the effects of weather associated with the heavy precipitation experienced during 2013.


LIQUIDITY AND CAPITAL RESOURCES

Overview

Our primary sources of liquidity for the nine months ended September 30, 2013 were $15.1 million provided by cash flow from operating activities, $4.7 million in net contributions and advances from developers and $1.7 million in net proceeds from the issuance of common stock. 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 ensure that 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.

Investment in Plant and Systems

The primary focus of Artesian Water's investment was to continue to provide high quality reliable service to our growing service territory. We invested $13.9 million in capital expenditures during the first nine months of 2013 compared to $14.8 million invested during the same period in 2012. During the first nine months of 2013, we invested $1.5 million to enhance or improve existing treatment facilities and for the rehabilitation of pumping equipment to better serve our customers. We invested $0.5 million to upgrade and automate our meter reading equipment. We invested approximately $0.6 million for our rehabilitation program for transmission and distribution facilities by replacing aging or deteriorating mains and for new transmission and distribution facilities. We invested approximately $4.2 million in mandatory utility plant expenditures due to governmental highway projects which require the relocation of water service mains in addition to facility improvements and upgrades.
Developers financed $3.4 million for the installation of water mains and hydrants for the first nine months of 2013 compared to $1.2 million for the first nine months of 2012. We invested $0.5 million for equipment purchases, computer hardware and software upgrades, and furniture and equipment related to renovations made to our main office building located in New Castle County. We also invested $1.9 million to upgrade our customer service software. The investment in general plant also includes an additional investment of $0.3 million for transportation and equipment purchases. An additional $1.0 million was invested in wastewater projects in Delaware.

Lines of Credit

At September 30, 2013, Artesian Resources had a $40 million line of credit with Citizens Bank, or Citizens, which is available to all subsidiaries of Artesian Resources. As of September 30, 2013, there was $36.3 million of available funds under this line of credit. The interest rate for borrowings under this line is the London Interbank Offered Rate, or LIBOR, plus 1.00%. This is a demand line of credit and therefore the financial institution may demand payment for any outstanding amounts at any time. The term of this line of credit expires on the earlier of May 29, 2014 or any date on which Citizens demands payment.

At September 30, 2013, Artesian Water had a $20 million line of credit with CoBank, ACB, or CoBank, that allows for the financing of operations for Artesian . . .

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