ARTESIAN RESOURCES CORP annual report, FY2014

Business context and reporting period

Artesian Resources Corporation’s Form 10-K covers the fiscal year ended December 31, 2014. The company provides regulated water and wastewater services and non-regulated contract operations and service-line protection plans, principally on the Delmarva Peninsula. Water sales represented 89.2% of annual operating revenue.

Fourth-quarter 2014 revenue was $18.1 million, operating income was $3.9 million, and net income applicable to common stock was $2.1 million, or $0.24 per share. In fourth-quarter 2013, the respective amounts were $16.9 million, $3.3 million, and $1.5 million, or $0.18 per share.

Key financial metrics

Operating revenue grew 4.9%; water sales rose 4.6%, reflecting temporary Delaware rate increases and higher consumption. Operating income margin, calculated as operating income divided by revenue, was approximately 22.1%, versus 21.0% in 2013. Management reported the ratio of operating expense excluding depreciation and income taxes to revenue improved to 57.1% from 59.0%.

At year-end, total assets were $422.2 million, cash and cash equivalents were $0.2 million, and current assets and current liabilities were $16.6 million and $30.2 million, respectively. Long-term debt, including current maturities, was $106.2 million; outstanding lines of credit were $18.5 million. The company reported $41.5 million of available capacity under its two credit lines and was in compliance with debt covenants. Debt to total capitalization, including short-term borrowings, was 45.8%.

Material changes versus the prior comparable period

• Revenue increased $3.4 million and net income rose $1.2 million. Higher water revenue and lower legal costs contributed; payroll and benefit costs, depreciation, taxes, and interest expense increased.
• Operating cash flow declined $2.7 million to $18.3 million, while capital expenditures increased $2.5 million. The company funded the investment gap with financing, including an $8.2 million net increase in line-of-credit borrowing.
• Water distributed rose to 7.6 billion gallons from 7.3 billion; metered customers increased to 82,900 from 81,900. Utility plant, net of accumulated depreciation, grew to $393.8 million from $379.0 million.
• Temporary rates in Delaware helped reverse the prior year’s weather-related water-sales decline. In 2013, heavy precipitation had reduced water consumption and revenue.

Outlook, management commentary, risks and unusual items

• Rates: Artesian Water’s 2014 Delaware rate request sought a 15.9% annualized revenue increase, or about $10.0 million. Temporary increases were implemented in two steps, designed to produce annualized increases of 3.98% and 7.17%; part of the second step was held in reserve and excluded from net income. Permanent rates remained pending in the filing. A 0.34% DSIC was approved for January 2015.
• Investment and liquidity: Management forecast approximately $21.1 million of 2015 utility-plant investment, partially offset by expected developer contributions and advances of $5.9 million. It expected to use operating cash, cash balances, credit lines, and capital-market financing as needed. The Citizens Bank $40 million demand line, with $31.5 million available at year-end, was due to expire May 28, 2015 unless renewed and could be called earlier. Expected 2015 interest, principal, rent, and water-interconnection payments totaled approximately $12.0 million.
• Debt and market exposure: Most long-term debt is fixed-rate, while the credit lines carry variable LIBOR-based rates. Management also identified exposure to changes in chemical, electricity, and other commodity costs, and noted cost recovery depends in part on regulatory rate decisions.
• Litigation: A court ruled that Artesian owed Chester Water Authority approximately $3.1 million for previously withheld water charges; the company paid this in October 2014. Approximately $379,000 of interest was accrued at year-end and paid in January 2015. The court did not require a separate approximately $300,000 late fee.
• Taxes: A tax accounting method change produced deductions for qualifying utility-system repair costs. The company reported a $6.0 million federal net operating loss to carry back, estimating refunds of $1.2 million and an additional $0.8 million alternative minimum tax credit. Deferred income tax expense was notably higher than in 2013.
• Principal risks: Results are sensitive to weather and water consumption, regulatory approval and timing of rate recovery, access to capital and refinancing, water supply permits and drought, environmental requirements, system reliability, wastewater overflows, and competition for new service territories. Management stated it was in material compliance with current water-quality standards and believed available water capacity was sufficient for foreseeable needs.
• Audit and controls: The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded controls were effective.

Important facts for investors to verify

• Whether and when Delaware regulators finalized the pending water rate case, including the treatment of temporary-rate reserves and the 2015 DSIC.
• Renewal or replacement terms for the Citizens Bank demand credit line that was scheduled to expire in May 2015, and subsequent liquidity and borrowing levels.
• Actual 2015 capital spending, developer contributions, operating cash flow, and funding needs relative to management’s forecasts.
• Whether customer growth and water consumption persist, given weather-related variability and the dependence on water sales.
• Any later changes in debt covenants, refinancing plans, regulatory requirements, or litigation and tax outcomes.