Artesian Resources Corporation — FY 2016 Form 10-K
Business and period: Artesian Resources is a regulated water and wastewater utility and provider of contract and service-line protection services, operating primarily on the Delmarva Peninsula. This annual report covers the fiscal year ended December 31, 2016; it is not a standalone fourth-quarter filing. Water sales generated 89.3% of annual operating revenue.
Financial performance and position
- Revenue: $79.1 million, up 2.7% from $77.0 million in 2015. Water sales rose 2.4% to $70.6 million; other utility revenue was $3.8 million and non-utility revenue was $4.7 million.
- Profit: Operating income was $18.8 million versus $17.6 million; net income applicable to common stock was $13.0 million versus $11.3 million. Diluted EPS increased to $1.41 from $1.26.
- Margins and costs: Operating margin was approximately 23.8% of revenue (2015: 22.8%). Operating expenses excluding depreciation and income taxes were 54.1% of revenue, down from 55.6%. Depreciation and amortization rose 4.0% to $9.2 million. Effective tax rate was 39.1%, compared with 40.8%.
- Cash flow and investment: Operating cash flow was $29.8 million, compared with $28.4 million. Capital expenditures were $28.3 million, up from $20.7 million. Dividends paid were $8.2 million; net cash from financing activities was a $1.6 million outflow.
- Debt and liquidity: Long-term debt, including current maturities, was $103.6 million; lines of credit outstanding were $7.1 million. Debt to total capitalization was 42.7%, and the company reported compliance with debt covenants. It had $52.9 million of unused capacity across $60 million of credit lines at year-end, but cash was only $226,000. One line was callable on demand; both credit facilities were due for renewal in 2017.
- Balance sheet and dividends: Total assets were $451.0 million and stockholders’ equity was $139.0 million. Annual dividends declared were approximately $0.90 per share, up from $0.87.
Changes versus 2015
- Revenue growth reflected higher Distribution System Improvement Charge (DSIC) revenue, increased water consumption and customer growth, plus higher service-line protection and contract revenue. Water customers in Delaware increased by approximately 1,300 to 82,700; total metered water customers were approximately 85,000.
- Operating income and net income improved as water revenue increased and utility operating expenses declined. Interest expense fell $0.4 million, partly because the Series S bond rate reset from 6.73% to 4.45% and short-term borrowing declined.
- Capital expenditures increased by $7.6 million, principally reflecting transmission and distribution work, meter upgrades and developer-financed utility plant. Utility plant net of accumulated depreciation rose to $425.5 million from $405.6 million.
- DSIC revenue rose to $1.306 million from $520,000. The cumulative DSIC rate approved for January 2017 was 4.71%, subject to later audit.
Outlook, material items and risks
- Investment outlook: Management expected 2017 gross investment of approximately $51.5 million, offset by $10.8 million of developer contributions and advances, for net investment of about $40.7 million. It expected 2017 interest, principal, lease and water-purchase obligations of approximately $11.3 million. Management believed operating cash flow and existing credit facilities would meet near-term working-capital needs, while noting future acquisitions could require additional debt or equity.
- Financing after year-end: In January 2017 Artesian Water issued a $40 million, 4.24% first mortgage bond due 2036. Proceeds were used to prepay the $20 million Series O bond (8.17%), including $4.5 million in prepayment costs, and the $15.4 million Series Q bond (4.75%); the DEPSC approved deferral of the Series O prepayment costs.
- Growth projects: A Sussex County wastewater agreement with Allen Harim provides for sanitary wastewater services after a pipeline expected in Q2 2017. A second agreement, signed in January 2017, covers disposal of about 1.5 million gallons per day of treated industrial wastewater, with an approximately eight-mile pipeline and 67-million-gallon lagoon expected in Q1 2018. Artesian also agreed to buy Fort DuPont water assets for $1.0 million, subject to closing, and develop the system for planned growth.
- Regulatory and legal exposure: The DEPSC’s final 2016 order confirmed a permanent annualized rate increase of approximately $6.0 million, or 9.5%, below the company’s requested $10.0 million. A portion of earlier temporary collections was refunded, with interest. A developer dispute over Contributions in Aid of Construction generated legal expense; the DEPSC denied the company’s request for deferred accounting treatment in December 2016. Management said ordinary-course proceedings were not expected to materially affect results, but outcomes remain uncertain.
- Principal risks: Earnings depend heavily on regulated water sales and timely, adequate rate relief; demand varies with weather and season. Other risks include drought and water-allocation limits, stricter environmental standards, wastewater system failures or overflows, capital-market access and refinancing, interest-rate exposure on variable-rate borrowing, customer growth and franchise approvals, and cyber or water-supply disruptions. Management stated it believed current capacity was sufficient for foreseeable demand and that the company was in material compliance with current water-quality standards.
- Audit and controls: BDO issued an unqualified opinion on the financial statements and internal control over financial reporting; management also assessed controls as effective.
Investor verification priorities
- Confirm the January 2017 Series T bond proceeds, redemption of Series O and Q, and accounting and regulatory recovery of the $4.5 million prepayment cost.
- Track renewal of the Citizens and CoBank credit facilities, including demand-call exposure, borrowing costs and covenant compliance.
- Monitor delivery, capital spending and expected revenue from the Allen Harim wastewater projects and Fort DuPont transaction.
- Review the status and financial effect of the developer CIAC dispute and any future rate or DSIC proceedings.
- Assess whether projected 2017 investment, developer contributions and operating cash flow support the dividend and liquidity plan, given low year-end cash.