Artesian Resources - 10-Q quarterly report FY

Basic net income per share is based on the weighted average number of common shares outstanding. Diluted net income per share is based on the weighted average number of common shares outstanding and the potentially dilutive effect of employee stock options. The following table summarizes the shares used in computing basic and diluted net income per share:

The office building and shop complex utilized by Artesian Water were leased at an average annual rental of $173,000 from the former partners of White Clay Realty who now own the property jointly as tenants in common. Dian C. Taylor, Chair and Chief Executive Officer of Artesian Resources, is a tenant in common and John R. Eisenbrey, Jr., a director of Artesian Resources, is a beneficiary of a tenant in common. The rental of $173,000 is below market rates. In December 2002, Artesian Water filed a condemnation action in the Delaware Superior Court, seeking to acquire title to the office and shop complex leased by Artesian Water, known as 664 Churchmans Road, Newark, Delaware (the "Property"). Artesian Water filed this action under its statutory power of eminent domain against the owner of the Property, White Clay Realty, a Delaware Limited Partnership, and each of the limited partners. The Superior Court ruled that since White Clay Realty had no general partner, the partnership is di ssolved and all of the former partners own the Property jointly as tenants in common. A special committee of the Board of Directors of Artesian Resources, composed entirely of outside directors who have no ownership interest in the Property, made the determination to purchase the Property through the condemnation procedures. Under this procedure, if the acquisition of the Property is approved by the court, the fair market value of the Property will be determined by a panel of commissioners after an evidentiary hearing. Artesian Water's independent appraiser valued the Property to be worth $3,800,000. In December 2002, Artesian Water issued a payment to the Prothonotary for the State of Delaware for $3,800,000. As the court delayed payment until the matter is decided, the amount was refunded to Artesian Water in June 2003. Until a final determination of the condemnation, the parties agreed that Artesian Water may continue to occupy the Property under the terms of the lease with a quarterly rental paymen t of $43,361. Pursuant to a deadline set by the Superior Court, the owners of the Property submitted an independent appraisal that values the Property to be worth $4,800,000. The condemnation case was scheduled for trial on October 20, 2003, wherein the fair market value of the Property would be determined by a panel of three Commissioners after an evidentiary hearing. Prior to the commencement of the trial all parties agreed to settle the case for a purchase price of $4,500,000 to be paid by Artesian Water. The decision to settle on the part of Artesian Water was made by the Special Committee of independent directors and with the recommendation of special counsel to the Special Committee. The settlement was approved by order of the Superior Court on October 20, 2003. The Court also approved applications of two of the tenants in common (neither of whom is an officer or director of Artesian) for their expenses, totaling $50,000, to be paid by Artesian Water, to which applications Artesian Water did not object.

ARTESIAN RESOURCES CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE PERIOD ENDED SEPTEMBER 30, 2003

RESULTS OF OPERATIONS

Overview

Strategic Direction

Our profitability is primarily attributable to the sale of water by Artesian Water, the amount of which is dependent on seasonal fluctuations in weather, particularly during the summer months when water demand may vary with rainfall and temperature.

While customer growth in our utility subsidiaries will continue to be a major focus in 2003, we are aggressively seeking opportunities that produce revenue streams that are not as directly affected by weather. These opportunities include our wastewater management subsidiary's operation of a new spray irrigation wastewater treatment facility with a capacity of 2.5 million-gallons-per-day for the town of Middletown, Delaware, which began operations in the third quarter of 2002. In addition, we will continue to focus attention on expanding our contract operations opportunities with municipalities and private water providers in Delaware and surrounding areas.

Ensuring our customers have a dependable supply of safe, high-quality water has been, and will continue to be, a high priority. We expect to make investments in 2003 that will increase our sources of water and enhance our ability to deliver supply from our Aquifer Storage and Recovery Program. We are the first and only water utility in Delaware to utilize this technology that capitalizes on Delaware's unique geology to provide storage capacity for water to be used during periods of peak water demand.

Regulatory Matters and Inflation

As of September 30, 2003, we had approximately 69,000 metered customers and serviced a population of approximately 230,000, representing approximately 29% of Delaware's total population. The Delaware PSC regulates Artesian Water's rates charged for water service, the sale and issuance of our securities and other matters. We periodically seek rate increases to cover the cost of increased operating expenses, increased financing expenses due to additional investments in utility plant and other costs of doing business. In Delaware, utilities are permitted by law to place rates into effect, under bond, on a temporary basis pending completion of a rate increase proceeding. If such rates are found to be in excess of rates the PSC finds to be appropriate, the utility must refund the portion found in excess to customers with interest. Increases in the number of customers served by Artesian Water also contribute to increases in our operating revenues.

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.

Delaware statute permits water utilities to put into effect, on a semi-annual basis, increases related to specific types of distribution system improvements through a Distribution System Improvement Charge (DSIC). This charge is available to water utilities to be implemented between general rate increase applications that normally recognize changes in a water utility's overall financial position. The DSIC process significantly reduces expenses when compared to those typically associated with general rate increase requests. We requested on May 30, 2003 and subsequently implemented a 0.39% overall surcharge for bills rendered subsequent to July 1, 2003. Through this charge, we expect to generate approximately $75,000 in revenues during 2003.

Operating Revenues

Revenues totaled $9.2 million and $27.2 million for the quarter and nine months ended September 30, 2003, 2.5% below and 5.3% above revenues for the quarter and nine months ended September 30, 2002, respectively. Water sales revenues decreased 1.9% for the quarter and increased 4.6% for the nine months ended September 30, 2003 over the corresponding periods in 2002. Despite customer growth and rate increases approved by the Delaware PSC, revenues for the nine months ended September 30, 2003 were negatively impacted by a decrease in water consumption due to a wet and cool summer. The remaining increase in operating revenues for the nine months ended September 30, 2003 is primarily due to additional revenues generated by wastewater services. We realized 97.8% and 96.9% of our total revenue for the quarter and nine months ended September 30, 2003, respectively, from the sale of water.

On April 2, 2002, Artesian Water filed a petition with the Delaware PSC seeking to raise rates for water service by 23.12% or $7.5 million. The Delaware PSC, on April 16, 2002, suspended the implementation of the proposed new rates pending further investigation and public evidentiary hearings. Pending these hearings and a final ruling by the Delaware PSC, Artesian Water, as is permitted by law, placed 7.71% of the proposed rates into effect under bond beginning June 1, 2002. Beginning December 3, 2002, Artesian Water placed an additional 3.69% of the proposed rates into effect. On April 15, 2003, the Delaware PSC issued PSC Order No. 6147 approving an increase in Artesian Water's revenue requirement of 9.68% effective May 1, 2003. These rates represent an increase in water consumption charges, customer charges, and fire hydrant ready-to-serve charges necessary to generate an increase in annual operating revenues of approximately $3.3 million. Since temporary rates were in excess of the final rate increase, in June 2003 we refunded approximately $201,000 plus interest to our customers. Since Artesian Water had reserved revenue related to the second temporary increase of $234,000, an additional $33,000 was recorded to revenue.

In addition, Artesian Wastewater, our non-regulated subsidiary, provides wastewater management and operations service for two wastewater treatment plants in Delaware. These services provide us with another source of revenue and are outside of the regulatory environment. Non-utility Operating Revenue from wastewater services decreased $50,000 for the quarter and increased $130,000 for the nine months ended September 30, 2003, over the same period last year. The decrease for the quarter ended September 30, 2003 reflects an adjustment to profit sharing revenues with Artesian Wastewater's partners, recorded in August 2003 and the increase for the nine months ended September 30, 2003 reflects the start of operation services for the second plant during the summer of 2002.

Operating Expenses

Operating expenses, excluding depreciation and taxes, increased $428,000, or 9.5%, to $4.9 million for the quarter ended September 30, 2003, and increased $588,000 for the nine months ended September 30, 2003 compared to the same period a year ago. The increase in operating expenses resulted primarily from an increase in payroll and related expense of $346,000, or 4.8%, principally due to increases in annual merit compensation, additional positions and an increase in employee benefit expense. An increase in purchased water expense of $175,000, or 8.0%, is a result of increases in our contractual obligations over the same period a year ago, when the required minimum takes were waived by our largest supplier due to the drought of 2002 and a rate increase placed in effect January 1, 2003 by Chester Water Authority. These increases were partially offset by a decrease in consulting and temporary services of $200,000. The ratio of operating expense, excluding depreciation and taxes, to tot al revenue was 53.6% for the nine months ended September 30, 2003, compared to 54.1% for the nine months ended September 30, 2002. Purchased water expense will continue to increase in the fourth quarter as we fulfill our minimum take obligations. It is anticipated that by the end of 2003, purchased water expense will be approximately $485,000 higher than it was at the end of 2002.

Interest charges increased $138,000 and $293,000, or 12.7% and 8.8%, over the quarter and nine months ended September 30, 2002, primarily due to an increase in interest related to the $25 million Series P First Mortgage Bond issued on January 31, 2003. This bond issuance replaced the Series L 8.03% $10 million bond and paid down our line of credit.

Net Income

Our net income applicable to common stock decreased $466,000 for the quarter ended September 30, 2003, and increased $25,000 for the nine months ended September 30, 2003 compared to the same periods a year ago. The decrease in net income for the quarter was due to reduced water sales related to weather and increased operating expenses related to payroll and benefits and purchased water. The increase in net income for the nine months was primarily due to rate increases authorized in 2002 and continued customer base growth.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity for the nine months ended September 30, 2003 were $10.3 million primarily from cash flow from operating activities. Cash flow from operating activities was primarily provided by our utility operations, and was impacted by the timeliness and adequacy of rate increases. It included the court ordered refund of $3.8 million from the Prothonotary for the State of Delaware in connection with the condemnation action for ownership of our office and shop complex.

A significant part of our ability to maintain and meet our financial objectives is to assure 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. On April 2, 2002, Artesian Water filed a petition with the Delaware PSC seeking to raise rates for water service and on April 15, 2003, the Delaware PSC issued PSC Order No. 6147 approving an increase in Artesian Water's revenue requirement of 9.68% effective May 1, 2003. These rates represent an increase in water consumption charges, customer charges and fire hydrant ready-to-serve charges necessary to generate an increase in annual operating revenues of approximately $3.3 million.

At September 30, 2003, Artesian Water had lines of credit with three separate financial institutions totaling $35.0 million to meet its temporary cash requirements. These revolving credit facilities are unsecured. As of September 30, 2003, we had $28.3 million of available funds under these lines. The interest rate for borrowings under each of these lines is the London Interbank Offering Rate plus 1.0% or, at our discretion, the bank's federal funds rate plus 1.0%. At September 30, 2003 our rate on these lines was 2.04%. All the facilities are reviewed annually by each bank for renewal. Our cash from operations and lines of credit are sufficient to meet our financial obligations for the next twelve months.

On February 21, 2003, Artesian Resources redeemed all 10,868 shares of our 7% Prior Preferred Stock. We incurred $54,000 in redemption premium costs associated with this buy-back.

CAUTIONARY STATEMENT

Statements in this Quarterly Report on Form 10-Q which express our "belief," "anticipation" or "expectation," as well as other statements which are not historical fact including statements regarding our customer growth, contract operations opportunities, investment plans in 2003, revenues from DSIC, purchased water expense, the acquisition of the office and shop complex and a dependable supply of safe, high-quality water the initiation of temporary rates, our investment plans in 2002 and whether we will conduct a debt offeringare forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and involve risks and uncertainties that could cause actual results to differ materially from those projected. Certain factors, such as competitive market pressures, material changes in demand from larger customers, changes in weather, changes in our contractual obligations, changes in government policies, changes in economic conditions, and other matters could cause re sults to differ materially from

those in the forward-looking statements. The CompanyThe Company does not undertake to update any of the forwarding looking statements included in the Quarterly Report on Form 10-Q.

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is subject to the risk of fluctuating interest rates in the normal course of business. Our policy is to manage interest rates through the use of fixed rate, long-term debt and, to a lesser extent, short-term debt. The Company's interest rate risk related to existing fixed rate, long-term debt is not material due to the term of our First Mortgage Bonds, which have maturity dates ranging from 2007 to 2020.

ITEM 4 - CONTROLS AND PROCEDURES

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.