Artesian Resources Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Artesian is a regulated water and wastewater utility operating primarily in Delaware, with regulated operations in Maryland and Pennsylvania, plus non-regulated contract services and service-line protection plans. Financial amounts below are in millions unless otherwise stated.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Operating revenue | $19.395 | $19.536 | $37.845 | $37.497 |
| Operating income | $4.669 | $4.985 | $8.522 | $8.657 |
| Net income applicable to common stock | $3.041 | $3.233 | $5.870 | $5.770 |
| Diluted EPS | $0.33 | $0.36 | $0.64 | $0.64 |
| Operating margin | 24.1% | 25.5% | 22.5% | 23.1% |
- Revenue drivers: Water sales were $17.323 million in Q2, down 0.9%, and $33.760 million for six months, up 0.7%. Water represented about 89% of revenue. Six-month non-utility revenue rose 3.5%, mainly from service-line protection plans and contract services.
- Cash flow: Six-month operating cash flow was $13.175 million, compared with $15.009 million a year earlier. Capital expenditures were $12.050 million versus $9.581 million. Cash increased $14,000 to $223,000; dividends paid were $4.052 million.
- Liquidity and debt: At June 30, cash was $0.223 million and current assets were $13.987 million, versus current liabilities of $17.452 million. Long-term debt, including current maturities, was $104.294 million; lines of credit outstanding were $4.818 million. The company reported 43.5% debt to total capitalization and compliance with debt covenants. Of $60 million in bank credit lines, $55.2 million was available.
- Other balance-sheet measures: Total assets were $438.958 million, stockholders’ equity $135.388 million, and net contributions in aid of construction $108.118 million. The filing reports fixed-rate long-term debt fair value of $120.635 million versus carrying value of $104.294 million.
Changes versus comparable periods
- Q2 revenue declined 0.7%, operating income fell 6.3%, and net income declined 5.9%. Management attributed the revenue decrease mainly to cooler, wetter May weather reducing water consumption; lower water-utility margins and increased legal costs contributed to lower net income.
- For the first six months, revenue increased 0.9% and net income increased 1.7%, while operating income declined 1.6%. Lower interest expense, including the Series S bond rate reset from 6.73% to 4.45% effective March 1, 2016, supported the net-income increase.
- Six-month operating cash flow fell about 12%, while capital expenditures rose about 26%. Utility plant increased to $413.642 million from $405.606 million at year-end 2015.
- Operating expense ratios excluding depreciation and income taxes increased to 53.9% from 52.1% in Q2 and to 55.0% from 54.6% for six months.
Outlook, risks, and unusual items
- Rates: Delaware’s final rate order provided an approximately $6.0 million annualized revenue increase, below the company’s requested $10.0 million. A 2.30% cumulative Distribution System Improvement Charge was approved effective July 1, 2016, subject to later audit; it generated $0.506 million in revenue in the first half.
- Investment and financing: Management expects to fund the next 12 months with operating cash flow, cash balances, bank credit lines, and capital-market financing as needed, and believes available internal funds and credit facilities are adequate. The $40 million Citizens demand line expires no later than May 26, 2017; the company expects renewal. The $20 million CoBank line expires July 20, 2017.
- Growth plans: Management intends to expand water and wastewater service, contract operations, and protection plans across the Delmarva Peninsula. The three-year capital plan includes water and wastewater system improvements and capacity projects. No specific earnings or revenue guidance was provided.
- Risks: Results are sensitive to weather-driven water demand and the timing and sufficiency of regulatory rate decisions. Other disclosed exposures include litigation costs, variable-rate borrowing, commodity costs, construction and economic conditions, and the need to renew credit facilities. The company said risk factors were unchanged from its 2015 Form 10-K.
- Unusual items: Completion of an IRS review of the 2014 filing and related carryback resulted in no change to tax liability and a reversal of approximately $201,000 of previously recorded reserves. The company continued to accrue small amounts of interest and penalties related to possible disallowance of a repair deduction. Legal costs increased due to a DEPSC proceeding involving a developer dispute over contributions in aid of construction.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It does not believe ordinary-course litigation will materially affect results, but notes that litigation can involve significant expense and management distraction.
Important facts for investors to verify
- Whether the July 2016 DSIC increase and final Delaware rate award provide timely, adequate recovery of investment and operating costs.
- Progress and spending on the elevated capital program, and the effect of capital needs on borrowing and cash flow.
- Renewal terms and availability of the Citizens and CoBank credit facilities, including the demand feature of the Citizens line.
- Developments in the developer-related DEPSC litigation and the tax authorities’ treatment of the repair deduction.
- Whether customer growth, weather, and protection-plan and contract-service growth support management’s stated expansion strategy.