MSEX

Business Context and Reporting Period

Company: Middlesex Water Company (MSEX)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2005
Overview: Middlesex Water Company operates regulated water and wastewater utility systems in central and southern New Jersey and Delaware. The company serves approximately 58,500 retail customers in New Jersey and 28,300 in Delaware. It also operates municipal systems under contract, most notably the City of Perth Amboy system. The company is regulated by the New Jersey Board of Public Utilities (BPU) and the Delaware Public Service Commission (PSC).

Key Financial Metrics

Capital Expenditures: $25.3 million in 2005. Projected capital expenditures are $44.5 million for 2006, $68.5 million for 2007, and $43.7 million for 2008.

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased 5.1% to $74.6 million. This was driven by a $3.6 million increase in water sales in the Middlesex system (due to rate increases and drier weather) and growth in Delaware customer base and rates.
• Expense Increases: Operating and maintenance expenses rose 5.4% to $42.2 million. Key drivers included a $1.9 million increase in New Jersey payroll/benefits, higher water production costs (electricity, chemicals), and increased Delaware employee costs.
• Non-Regulated Segment: Revenues from the non-regulated segment (USA) decreased by $2.2 million due to the completion of a meter services venture in late 2004.
• EPS Decline: Despite a slight increase in Net Income, Basic EPS decreased from $0.74 to $0.72 due to an increase in average shares outstanding following a 2004 stock offering and dividend reinvestment plan issuances.
• Debt Levels: Long-term debt increased by approximately $12.9 million to $128.2 million to fund capital projects.

Guidance, Outlook, and Risks

Outlook and Guidance:

• Rate Relief: The company received an 8.7% ($4.3 million) rate increase for the Middlesex system in December 2005. A decision on a 10.3% rate increase for the Pinelands system is expected in Q2 2006. A rate increase filing for the Tidewater (Delaware) system is planned for 2006.
• Cost Pressures: Management anticipates significant cost increases in 2006, including a potential 40% rise in Delaware electricity costs due to deregulation, higher pension/postretirement costs, and increased payroll expenses.
• Capital Needs: The company projects capital expenditures of approximately $112.2 million for 2007-2008, to be funded by internal cash flow, State Revolving Fund (SRF) loans, and potential equity offerings.

Risks and Contingencies:

• Regulatory Risk: Future earnings depend on the approval and timing of rate increases by the BPU and PSC. There is no assurance that requested increases will be granted.
• Legal Proceedings: Tidewater is appealing a Delaware State Fire Marshal Notice of Violation regarding fire protection services. An unfavorable outcome could require a capital investment of $0.9 million to $1.6 million for one system, with potential material costs for over 60 other systems.
• Guarantees: The company guarantees approximately $23.9 million of Perth Amboy municipal bonds. While reimbursement provisions exist, a default by the city could require Middlesex to fund debt service.
• Weather Dependence: Revenue is sensitive to weather conditions; droughts may increase demand but also restrict supply, while cool/wet weather reduces consumption.

Investor Verification Checklist

• Rate Case Outcomes: Monitor the BPU decision on the Pinelands rate increase and the PSC response to the upcoming Tidewater filing, as these are critical for margin recovery.
• Delaware Electricity Costs: Verify the actual impact of electricity deregulation on operating expenses in 2006, as a 40% increase was projected.
• Fire Protection Litigation: Track the appeal of the Delaware Fire Marshal Notice of Violation to assess potential capital expenditure risks for the Tidewater system.
• Capital Funding: Confirm the execution of the planned public equity offering in late 2006 or early 2007 to fund the aggressive capital program.
• Perth Amboy Guarantee: Review the financial health of the City of Perth Amboy to assess the risk of the $23.9 million bond guarantee.