UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number 0-18516 ARTESIAN RESOURCES CORPORATION ---------------------------------------------------- (exact name of registrant as specified in its charter) <TABLE> <CAPTION> <S> <C> State or other jurisdiction of incorporation or organization: DELAWARE I.R.S. Employer Identification Number: 51-0002090 Address of principal executive officers: 664 CHURCHMANS ROAD NEWARK, DELAWARE 19702 Registrant's telephone number, including area code: (302) 453 - 6900 </TABLE> Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Indicate by check mark whether the registrant is an accelerated filer as defined in Rule 12b-2 of the Exchange Act. [X] Yes [ ] No As of October 29, 2004, 3,359,627 shares of Class A Non-Voting Common Stock and 587,680 shares of Class B Common Stock were outstanding.
ARTESIAN RESOURCES CORPORATION INDEX TO FORM 10-Q <TABLE> <CAPTION> Page(s) <S> <C> <C> <C> PART I - FINANCIAL INFORMATION: ITEM 1 - FINANCIAL STATEMENTS Consolidated Balance Sheet September 30, 2004 and December 31, 2003 3 Consolidated Statement of Income for the quarter ended September 30, 2004 and 2003 4 Consolidated Statement of Income for the nine months ended September 30, 2004 and 2003 5 Consolidated Statement of Retained Earnings for the nine months ended September 30, 2004 and 2003 6 Consolidated Statement of Cash Flows 7 for the nine months ended September 30, 2004 and 2003 Notes to the Consolidated Financial Statements 8 - 11 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 12 - 18 ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 18 ITEM 4 - CONTROLS AND PROCEDURES 18 PART II - OTHER INFORMATION: ITEM 1 - LEGAL PROCEEDINGS 19 ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K 19 SIGNATURES 20 INDEX TO EXHIBITS 21 </TABLE>
PART I - FINANCIAL INFORMATION ITEM I - FINANCIAL STATEMENTS ARTESIAN RESOURCES CORPORATION CONSOLIDATED BALANCE SHEET (In thousands) <TABLE> <CAPTION> (Unaudited) September 30, 2004 December 31, 2003 ------------------ ----------------- <S> <C> <C> ASSETS Utility plant, at original cost less accumulated depreciation $ 208,364 $ 187,893 Current assets Cash and cash equivalents 1,162 1,128 Accounts receivable, net 2,949 2,408 Income tax receivable 404 841 Unbilled operating revenues 3,146 2,745 Materials and supplies-at cost on FIFO basis 955 801 Prepaid property taxes 1,148 711 Prepaid expenses and other 1,430 577 ---------- ---------- 11,194 9,211 ---------- ---------- Other assets Non-utility property (less accumulated depreciation 2004-$103; 2003-$89) 342 334 Restricted cash 1,420 14,219 Other deferred assets 2,650 2,544 ---------- ---------- 4,412 17,097 Regulatory assets, net 2,032 2,123 ---------- ---------- $ 226,002 $ 216,324 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Stockholders' equity Common stock $ 3,946 $ 3,901 Additional paid-in capital 41,950 41,160 Retained earnings 8,349 7,630 ---------- ---------- Total stockholders' equity 54,245 52,691 Long-term debt, net of current portion 83,073 80,558 ---------- ---------- 137,318 133,249 ---------- ---------- Current liabilities Notes payable 11,162 12,499 Current portion of long-term debt 364 188 Current portion of mandatorily redeemable preferred stock -- 100 Accounts payable 2,747 3,951 Overdraft payable 1,747 1,337 Deferred income taxes -- 213 Interest accrued 487 267 Customer deposits 460 422 Other 1,267 697 ---------- ---------- 18,234 19,674 ---------- ---------- Deferred credits and other liabilities Net advances for construction 21,398 19,175 Postretirement benefit obligation 1,186 1,232 Deferred investment tax credits 823 843 Deferred income taxes 14,960 11,775 ---------- ---------- 38,367 33,025 Commitments and contingencies Net contributions in aid of construction 32,083 30,376 ---------- ---------- $ 226,002 $ 216,324 ========== ========== </TABLE> See notes to the consolidated financial statements. 3
ARTESIAN RESOURCES CORPORATION CONSOLIDATED STATEMENT OF INCOME (Unaudited) (In thousands, except per share amounts) <TABLE> <CAPTION> For the Quarter Ended September 30, -------------------------------- 2004 2003 ---------- --------- <S> <C> <C> OPERATING REVENUES Water sales $ 10,133 $ 9,021 Other utility operating revenue 248 164 Non-utility revenue 220 42 ---------- --------- 10,601 9,227 ---------- --------- OPERATING EXPENSES Utility operating expenses 4,958 4,830 Related party expenses -- 43 Non-utility operating expenses 142 63 Depreciation and amortization 998 904 State and federal income taxes 993 653 Property and other taxes 537 529 ---------- --------- 7,628 7,022 ---------- --------- OPERATING INCOME 2,973 2,205 OTHER INCOME, NET Allowance for funds used during construction 6 67 Miscellaneous income (expense) (6) 10 ---------- --------- INCOME BEFORE INTEREST CHARGES 2,973 2,282 INTEREST CHARGES 1,493 1,227 ---------- --------- NET INCOME 1,480 1,055 PREFERRED DIVIDEND REQUIREMENT -- 3 ---------- --------- NET INCOME APPLICABLE TO COMMON STOCK $ 1,480 $ 1,052 ========== ========= INCOME PER COMMON SHARE: Basic $ 0.38 $ 0.27 ========== ========= Diluted $ 0.36 $ 0.26 ========== ========= CASH DIVIDEND PER COMMON SHARE $ 0.2075 $ 0.1984 ========== ========= AVERAGE COMMON SHARES OUTSTANDING Basic 3,944 3,885 ========== ========= Diluted 4,073 3,985 ========== ========= </TABLE> See notes to the consolidated financial statements. 4
ARTESIAN RESOURCES CORPORATION CONSOLIDATED STATEMENT OF INCOME (Unaudited) (In thousands, except per share amounts) <TABLE> <CAPTION> For the Nine Months Ended September 30, ------------------------------- 2004 2003 ---------- ---------- <S> <C> <C> OPERATING REVENUES Water sales $ 28,166 $ 26,373 Other utility operating revenue 652 564 Non-utility revenue 554 281 ---------- --------- 29,372 27,218 ---------- --------- OPERATING EXPENSES Utility operating expenses 15,138 14,294 Related party expenses -- 130 Non-utility operating expenses 348 161 Depreciation and amortization 3,014 2,640 State and federal income taxes 2,112 1,999 Property and other taxes 1,619 1,548 ---------- --------- 22,231 20,772 ---------- --------- OPERATING INCOME 7,141 6,446 OTHER INCOME, NET Allowance for funds used during construction 260 169 Miscellaneous income 186 41 ---------- --------- INCOME BEFORE INTEREST CHARGES 7,587 6,656 INTEREST CHARGES 4,430 3,610 ---------- --------- NET INCOME 3,157 3,046 PREFERRED DIVIDEND REQUIREMENT AND REDEMPTION PREMIUM 2 69 ---------- --------- NET INCOME APPLICABLE TO COMMON STOCK $ 3,155 $ 2,977 ========== ========= INCOME PER COMMON SHARE: Basic $ 0.80 $ 0.77 ========== ========= Diluted $ 0.78 $ 0.75 ========== ========= CASH DIVIDEND PER COMMON SHARE $ 0.6175 $ 0.5950 ========== ========= AVERAGE COMMON SHARES OUTSTANDING: Basic 3,931 3,875 ========== ========= Diluted 4,059 3,979 ========== ========= </TABLE> See notes to the consolidated financial statements. 5
ARTESIAN RESOURCES CORPORATION CONSOLIDATED STATEMENT OF RETAINED EARNINGS Unaudited (In thousands) <TABLE> <CAPTION> For the Nine Months Ended September 30, -------------------------- 2004 2003 -------- -------- <S> <C> <C> Balance, beginning of period $ 7,630 $ 6,973 Net income 3,157 3,046 -------- -------- 10,787 10,019 Less: Dividends 2,438 2,376 Common stock repurchase -- 83 -------- -------- Balance, end of period $ 8,349 $ 7,560 ======== ======== </TABLE> See notes to the consolidated financial statements. 6
ARTESIAN RESOURCES CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS Unaudited (In thousands) <TABLE> <CAPTION> For the Nine Months Ended September 30, ------------------------------ 2004 2003 ---------- --------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES NET INCOME $ 3,157 $ 3,046 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,014 2,640 Deferred income taxes, net 2,952 3,507 Allowance for funds used during construction (260) (169) Changes in assets and liabilities: Accounts receivable (541) (680) Receivable, other -- 3,800 Income tax receivable 437 -- Unbilled operating revenue (401) (172) Materials and supplies (154) (80) Accrued state and federal income taxes -- (135) Prepaid property taxes (437) (415) Prepaid expenses and other (853) (1,393) Other deferred assets (82) (198) Regulatory assets 91 134 Postretirement benefit obligation (46) (47) Accounts payable (1,204) 754 Interest accrued 220 (391) Customer deposits and other, net 608 132 ---------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES 6,501 10,333 ---------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (net of AFUDC) (23,677) (14,352) Investment In AquaStructure (4) -- Proceeds from sale of assets 11 2 ---------- -------- NET CASH USED IN INVESTING ACTIVITIES (23,670) (14,350) ---------- -------- CASH FLOW FROM FINANCING ACTIVITIES Net borrowings (repayments) under line of credit agreement (1,337) 3,551 Proceeds from issuance of long-term debt 15,314 644 Debt issuance costs (20) -- Overdraft payable 410 1,829 Net advances and contributions in aid of construction 4,363 995 Net proceeds from SRF loans 176 -- Net proceeds from stock transactions 835 448 Dividends (2,438) (2,376) Repayment of long-term debt -- (233) Redemption of preferred stock (100) (100) ---------- --------- NET CASH PROVIDED BY FINANCING ACTIVITIES 17,203 4,758 ---------- --------- NET INCREASE IN CASH AND CASH EQUIVALENTS 34 741 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,128 874 ---------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,162 $ 1,615 ========== ========= Supplemental Disclosures of Cash Flow Information: Interest paid $ 4,149 $ 3,963 ========== ========= Income taxes paid $ -- $ 150 ========== ========= </TABLE> See notes to the consolidated financial statements. 7
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - GENERAL Artesian Resources Corporation ("Artesian Resources" or the "Company") operates as a holding company, whose income is derived from the earnings of our wholly owned subsidiary companies and our one-third interest in AquaStructure Delaware, L.L.C., a Limited Liability Corporation whose primary activity is marketing wastewater services. Artesian Water Company, Inc. ("Artesian Water"), our principal subsidiary, is the oldest and largest public water utility in the State of Delaware and has been providing water service within the state since 1905. We distribute and sell water to residential, commercial, industrial, governmental, municipal and utility customers throughout Delaware. In addition, we provide services to other water utilities, including operations and billing functions, and have contract operation agreements with fifteen private and municipal water providers. Our other water utility subsidiary, Artesian Water Pennsylvania, Inc., began operations in 2002, providing water service to a residential community, consisting of 41 homes, in Chester County, Pennsylvania. On October 14, 2003, we filed an application with the Pennsylvania Public Utilities Commission to increase our service area in Pennsylvania. The application concerns four specific housing developments that are expected to add 350 customers over 10 years to the extent our application is approved. On September 30, 2004 we changed the name of our non-regulated subsidiary, Artesian Wastewater Management, Inc. ("Artesian Wastewater"), which operates municipal wastewater facilities under operating agreements, to Artesian Utility Development, Inc. Concurrent with this name change, we formed a new subsidiary, Artesian Wastewater Management, Inc., which will provide wastewater services to customers in Delaware as a regulated public wastewater service company. Our other subsidiary, which is not regulated, is Artesian Development Corporation, whose sole activity is the ownership of an eleven-acre parcel of land zoned for office buildings located immediately adjacent to our corporate headquarters. The terms "we", "our" and the "Company" as used herein refer to Artesian Resources and its subsidiaries. Stock Compensation Plans - ------------------------ At September 30, 2004, the Company had three stock-based compensation plans. The Company applies APB Opinion No. 25 and related interpretations in accounting for compensation expense under its plans. Accordingly, the aggregate compensation cost incurred under the three plans was a $75,300 and $124,800 charge against income for the quarter and nine months ended September 30, 2004 and $28,400 and $47,100 for the quarter and nine months ended September 30, 2003. Had compensation cost for the Company's three plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method required by Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation," the Company's net income and net income per common share would have been reduced to the pro-forma amounts indicated below: <TABLE> <CAPTION> For the Quarter Ended For the Nine Months Ended September 30, September 30, ------------------------ -------------------------- 2004 2003 2004 2003 ---------- -------- ---------- -------- <S> <C> <C> <C> <C> In thousands, except per share data NET INCOME APPLICABLE TO COMMON STOCK As reported $ 1,480 $ 1,052 $ 3,155 $ 2,977 Add: compensation expense included in net income (net of tax) 45 17 75 28 Deduct: compensation expense using fair value based method (net of tax) (115) (63) (197) (113) ------- -------- -------- -------- Pro-forma $ 1,410 $ 1,006 $ 3,033 $ 2,892 BASIC NET INCOME PER COMMON SHARE As reported $ 0.38 $ 0.27 $ 0.80 $ 0.77 Pro-forma $ 0.36 $ 0.26 $ 0.77 $ 0.75 DILUTED NET INCOME PER COMMON SHARE As reported $ 0.36 $ 0.26 $ 0.78 $ 0.75 Pro-forma $ 0.35 $ 0.25 $ 0.75 $ 0.73 </TABLE> 8
NOTE 2 - REGULATORY ASSETS Certain expenses are recoverable through rates charged to our customers, without a return on investment, and are deferred and amortized during future periods using various methods as permitted by the Delaware Public Service Commission ("Delaware PSC"). Expenses related to applications to increase rates are amortized on a straight-line basis over a period of two years. The postretirement benefit obligation, which is being amortized over 20 years, is adjusted for the difference between the net periodic postretirement benefit costs and the cash payments. The deferred income taxes will be amortized over future years as the tax effects of temporary differences previously flowed through to the customers reverse. Regulatory assets net of amortization, are comprised of the following: <TABLE> <CAPTION> September 30, 2004 December 31, 2003 ------------------- ------------------ (in thousands) <S> <C> <C> Postretirement benefit obligation $ 1,186 $ 1,232 Deferred income taxes recoverable in future rates 616 627 Expense of rate proceedings 120 220 Other 110 44 ---------- ---------- $ 2,032 $ 2,123 ========== ========== </TABLE> Expenses related to the Net Periodic Pension Cost for the postretirement benefit obligation are as follows: <TABLE> <CAPTION> FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 2003 -------- -------- <S> <C> <C> NET PERIODIC PENSION COST Interest Cost $ 43 $ 48 Amortization of Net (Gain) or Loss (27) (43) Amortization of Transition Obligation/(Asset) 6 6 -------- -------- Total Net Periodic Benefit Cost $ 22 $ 11 ======== ======== </TABLE> CONTRIBUTIONS Artesian Water contributed $67,000 to its postretirement benefit plan in the first nine months of 2004 and expects to contribute another $25,000 for the remainder of the year. These contributions consist of insurance premium payments for medical, dental and life insurance benefits made on behalf of the Company's eligible retired employees. NOTE 3 - RELATED PARTY TRANSACTIONS The office building and shop complex utilized by Artesian Water were previously leased at an average annual rental of $173,000 from the former limited partners of White Clay Realty, who owned the property jointly as tenants in common. Dian C. Taylor, Chair and Chief Executive Officer of Artesian Resources, was a tenant in common and John R. Eisenbrey, Jr., a director of Artesian Resources, was a beneficiary of a tenant in common. The rental of $173,000 was 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 9
Limited Partnership, and each of the limited partners. The Superior Court ruled that since White Clay Realty had no general partner, the partnership was dissolved and all of the former partners owned the Property jointly as tenants in common. A special committee (the "Special Committee") of the Board of Directors of Artesian Water, composed entirely of outside directors who had 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 were to be approved by the court, the fair market value of the Property would 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 was decided, the amount was refunded to Artesian Water in September 2003. Until a final determination of the condemnation, the parties agreed that Artesian Water could continue to occupy the Property under the terms of the lease with a quarterly rental payment of $43,361. Pursuant to a deadline set by the Superior Court, the owners of the Property submitted an independent appraisal that valued 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 have been determined by a panel of three Commissioners after an evidentiary hearing. Prior to the commencement of the trial on October 20, 2003, all parties agreed to settle the case for a purchase price of $4,500,000 paid by Artesian Water. The decision to settle on the part of Artesian Water was made by the Special Committee 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. Expenses associated with related party transactions were as follows: <TABLE> <CAPTION> For the Quarter For the Nine Months Ended September 30, Ended September 30, ---------------------- -------------------------- 2004 2003 2004 2003 ------ ------- -------- ------- (in thousands) (in thousands) <S> <C> <C> <C> <C> White Clay Realty $ -- $ 43 $ -- $ 130 ====== ====== ====== ======= </TABLE> NOTE 4 - NET INCOME PER COMMON SHARE AND EQUITY PER COMMON SHARE 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: <TABLE> <CAPTION> For the Quarter For the Nine Months Ended September 30, Ended September 30, ------------------- ------------------- 2004 2003 2004 2003 ------ ------ ------- ------ (in thousands) (in thousands) <S> <C> <C> <C> <C> Average common shares outstanding during the period for Basic computation 3,944 3,885 3,931 3,875 Dilutive effect of employee stock options 129 100 128 104 ----- ----- ----- ----- Average common shares outstanding during the period for Diluted computation 4,073 3,985 4,059 3,979 ===== ===== ===== ===== </TABLE> Equity per common share was $13.75 at September 30, 2004 and $13.46 at September 30, 2003. These amounts were computed by dividing common stockholders' equity, excluding preferred stock, by the number of shares of common stock outstanding on September 30, 2004 and 2003. 10
NOTE 5 - IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS In December 2003, the FASB issued revised Statement No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits-an amendment of FASB Statements No. 87, 88, and 106." This statement requires additional disclosures to those in the original Statement No. 132 about the assets, obligations, cash flows, and net periodic benefit cost of defined pension plans and other defined benefit postretirement plans. Disclosures for earlier periods presented for comparative purposes have been revised. This statement is effective for financial statements with fiscal years ending after December 15, 2003. The additional disclosures required for our postretirement benefit obligation are presented in Note 2. NOTE 6 - RATE PROCEEDINGS On February 5, 2004, Artesian Water filed a petition with the Delaware PSC to implement new rates to meet a requested increase in revenue of 24%, or approximately $8.8 million on an annualized basis. The Delaware PSC, on March 16, 2004, 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, the Company, as permitted by law, placed a portion of the proposed rates into effect on April 6, 2004. These temporary rates were designed to generate an increase in annual operating revenue of approximately 6.98%, or $2.5 million on an annualized basis. Beginning September 7, 2004, the Company placed the maximum portion of the proposed rates as permitted by law into effect. These rates were designed to generate an additional increase of approximately 8.02%, for a total increase of 15%, or approximately $5.5 million on an annualized basis. If such rates are found to be in excess of rates the Delaware PSC finds to be appropriate, we must refund the portion found in excess to customers with interest. On April 2, 2002, Artesian Water filed a petition with the Delaware PSC seeking to raise rates for water service by 23.12%, or an increase in revenues of $7.5 million on an annualized basis. Artesian Water, as permitted by law, placed into effect on September 1, 2002, a portion of the proposed increase in rates designed to generate an annualized increase in water sales revenues of $2.5 million, or a 7.71% increase in rates. Beginning December 3, 2002, Artesian Water, as permitted by law, placed an additional 3.69% increase in temporary rates into effect. On April 15, 2003, the Delaware PSC issued PSC Order No. 6147 approving an increase in Artesian Water's annual revenue requirement of 9.68% effective May 1, 2003. These rates represented 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 the temporary rates that we had placed into effect beginning December 3, 2002 were in excess of the final approved rate increase, in September 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 the second quarter of 2003. 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 approval process is less costly when compared to the approval process for general rate increase requests. We requested on November 30, 2003, and subsequently implemented, a 1.13% DSIC surcharge for bills rendered subsequent to January 1, 2004. This surcharge was designed to generate approximately $204,000 in revenues between January and September of 2004. However, as required by law, application of the DSIC surcharge was discontinued after the temporary rate increase was placed into effect on April 6, 2004. We billed $87,000 in revenues under this surcharge from January 1, 2004 through April 6, 2004. NOTE 7 - INCREASE TO LINES OF CREDIT At September 30, 2004, Artesian Water had lines of credit with two separate financial institutions totaling $40.0 million to meet its temporary cash requirements. These facilities increased by $5.0 million on approval of the Board of Directors on September 24, 2004. These revolving credit facilities are unsecured. As of September 30, 2004, we had $28.8 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, 2004 the rate on these lines was 2.62%. All the facilities are reviewed annually by each bank for renewal. 11
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS FOR THE PERIOD ENDED SEPTEMBER 30, 2004 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. In the event that temperatures during the typically warmer months are cooler than expected, or rainfall is greater than expected, the demand for water may decrease and our revenues may be adversely affected. We believe the effects of weather are short term and do not materially affect the execution of our strategic initiatives. While customer growth in our utility subsidiaries has been a major focus in the first nine months of 2004, we are aggressively seeking opportunities that produce revenue streams that are not as directly affected by weather. These opportunities include wastewater treatment services, including design, build, operate and ownership of systems throughout Delaware and surrounding areas. On September 30, 2004, we changed the name of our non-regulated subsidiary Artesian Wastewater Management, Inc., which operates municipal wastewater facilities under operating agreements, to Artesian Utility Development, Inc. This non-regulated subsidiary will continue to actively pursue opportunities to design, build and operate wastewater facilities throughout Delaware and surrounding areas. Concurrent with this change in name, we formed a new subsidiary, Artesian Wastewater Management, Inc., that will provide wastewater services to customers in Delaware as a regulated public wastewater service company. Artesian Wastewater intends to file an application with the Delaware Public Service Commission ("Delaware PSC") in the fourth quarter of 2004 to begin providing wastewater services as a regulated public utility to a development in Sussex County, Delaware. The opportunities generated through our wastewater service companies may provide additional service territory for the regulated water subsidiary or may provide contract operations services for municipalities or other regulated entities. We will also 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 have invested $23.7 million through the nine months ended September 30, 2004 related to assuring reliability of our systems and sources of supply in order to serve our customers. Last year Delaware passed legislation requiring all water utilities to certify by 2006 that they have sufficient sources of self-supply to serve their respective systems. We believe we have made the appropriate investment in infrastructure to file the required certification and intend to do so by the end of 2004. REGULATORY MATTERS AND INFLATION As of September 30, 2004, we had approximately 70,750 metered water customers and served 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 securities and other matters. On July 6, 2004, Delaware enacted legislation authorizing the Delaware PSC to regulate wastewater companies, which includes rates charged for wastewater service, issuance of securities and other matters. Our wastewater management subsidiary, Artesian Wastewater Management, Inc., intends to file an application for a Certificate of Public Convenience and Necessity ("CPCN") in the fourth quarter of 2004 to serve a 750 home residential community in Sussex County, Delaware. Artesian Wastewater currently has a permit pending to construct a 90,300 gallon per day facility to service this residential development. 12
Our regulated utilities 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. The first temporary increase may be up to the lesser of $2.5 million on an annual basis or 15% of annual gross water sales. Should the rate case not be completed within seven months, by law, the utility may put the lesser of the entire requested rate relief or 15% of annual gross water sales in effect, under bond, until a final resolution is ordered and placed into effect. If such rates are found to be in excess of rates the Delaware PSC finds to be appropriate, we must refund the portion found in excess to customers with interest. The timing of our rate increase requests are therefore dependent upon the estimated cost of the administrative process in relation to the investments and expenses that we hope to recover through the rate increase. We can provide no assurances that rate increase requests will be approved by applicable regulatory agencies; and, if approved, we cannot guarantee that these rate increases will be granted in a timely or sufficient manner to cover the investments and expenses for which we initially sought the rate increase. 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 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 is less costly when compared to the approval process for general rate increase requests. Results of Operations - Analysis of First Nine Months of 2004 Compared to First Nine Months of 2003 - ------------------------------------------------------------------------------- Operating Revenues - ------------------ Revenues totaled $29.4 million for the nine months ended September 30, 2004, $2.2 million, or 7.9% above revenues for the nine months ended September 30, 2003 of $27.2 million. Water sales revenues increased 6.8% for the nine months ended September 30, 2004 over the corresponding period in 2003. A portion of the increase in water sales revenue reflects a 1.9% increase in the number of customers served. The increase was also the result of the DSIC surcharge placed into effect on January 1, 2004, and a temporary rate increase placed into effect in two steps on April 6, 2004 and September 7, 2004, pursuant to the Company's 2004 rate application described below. However, recorded rainfall in New Castle County, Delaware, which is where 94.6% of Artesian Water's customer base reside, was nearly 40% above average for the nine months ended September 30, 2004 and 10% greater than the same time a year ago, which suppressed water demand and offset the expected increase in water sales from the implementation of temporary rates and the increased number of customers served. The remaining increase in operating revenues for the nine months ended September 30, 2004 is primarily due to additional revenues generated by wastewater and contract operations services. We realized 95.9% of our total revenue for the nine months ended September 30, 2004 from the sale of water. On February 5, 2004, Artesian Water filed a petition with the Delaware PSC to implement new rates to meet a requested increase in revenue of 24%, or approximately $8.8 million on an annualized basis. The Delaware PSC, on March 16, 2004, 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, the Company, as permitted by law, placed a portion of the proposed rates into effect on April 6, 2004. These temporary rates were designed to generate an increase in annual operating revenue of approximately 6.98%, or $2.5 million on an annualized basis. Beginning September 7, 2004, as is permitted by law, the Company placed an additional portion of the proposed rates into effect. These rates were designed to generate an additional increase of approximately 8.02%, for a total increase of 15%, or approximately $5.5 million on an annualized basis, the maximum level of temporary rates permitted by law. 13
We requested on November 30, 2003, and subsequently implemented, a 1.13% DSIC surcharge for bills rendered subsequent to January 1, 2004. This surcharge was designed to generate approximately $204,000 in revenues between January and June of 2004. However, as required by law, application of the DSIC surcharge was discontinued after the temporary rate increase was placed into effect on April 6, 2004. We billed $87,000 in revenues under this surcharge from January 1, 2004 through April 6, 2004. On April 2, 2002, Artesian Water filed a petition with the Delaware PSC seeking to raise rates for water service by 23.12%, or an increase in revenues of $7.5 million on an annualized basis. Artesian Water, as permitted by law, placed into effect on June 1, 2002, a portion of the proposed increase in rates designed to generate an annualized increase in water sales revenues of $2.5 million, or a 7.71% increase in rates. Beginning December 3, 2002, Artesian Water, as permitted by law, placed an additional 3.69% increase in temporary rates into effect. On April 15, 2003, the Delaware PSC issued PSC Order No. 6147 approving an increase in Artesian Water's annual revenue requirement of 9.68% effective May 1, 2003. Since the temporary rates that we had placed into effect beginning December 3, 2002 were in excess of the final approved rate increase, in September 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 the second quarter of 2003. Operating Expenses - ------------------ Operating expenses, excluding depreciation and income taxes, increased $1.0 million, or 6.0%, to $17.1 million for the nine months ended September 30, 2004, compared to $16.1 million for the same period in 2003. The components of the increase in operating expenses included increases in administrative expenses of $337,000, in payroll and employee benefit expense of $191,000, in repair and maintenance expense of $187,000, in property and other taxes of $71,000, in purchased water expense of $65,000, and in property and liability insurance expense of $47,000. Administration expenses increased approximately $337,000 for the nine months ended September 30, 2004, or 16.2%, primarily due to an increase in consulting expenses of $180,000. Engineering services for our wastewater subsidiaries comprised $129,000 of this increase. The engineering fees are charged back to developers under contract and the associated revenues have been reflected in our operating revenues under non-utility revenue. We also have incurred $65,000 in additional consulting expenses related to work involved with documenting internal controls to comply with the Sarbanes-Oxley Act of 2002. We expect to incur additional fees of approximately $130,000 by the end of the year related to this work. In addition, we anticipate increased fees from our auditors related to their review and testing of internal controls to range between $56,000 and $84,000, potentially a 40% to 60% increase in total auditing fees. These expense estimates do not reflect additional accounting personnel needs and management time relating to this effort. Administration expenses also increased due to an increase in regulatory expense of $104,000 that recognized the accelerated amortization of the 2002 rate application expenditures, the reimbursement of $70,000 in consulting expenses incurred by the PSC in connection with the review of supply conditions during 2002, and an increase in training costs of $54,000 primarily associated with recently purchased software systems. These increases were partially offset by a reduction of $130,000 in related party expense due to our purchase of the office and shop complex in October 2003, which we had previously leased from White Clay Realty. Payroll and associated employee benefits expense increased $191,000, or 2.5%, due to a $202,000 increase in medical insurance costs. The increase in the employee benefit expense was partially offset by a decrease in payroll expense, which declined primarily because of the capitalization of payroll associated with programming for the Company's new customer information system software. Our medical insurance premiums increased by 15% effective August 2003 and another 15% effective August 2004. The overall increase in repair and maintenance expense of $187,000, or 22.3%, is primarily comprised of $62,000 for maintenance programs associated with recently purchased software systems, $44,000 for the replacement of the filter media used in a new water treatment process at one of our facilities, $31,000 for expenses related to tank painting and maintenance, $27,000 related to increases in prices charged for transportation fuels and $31,000 related to work performed by outside service providers in maintaining the Company's grounds around our utility facilities. We expect to replace the filter media and incur these other expenses annually and have requested recovery of these on-going expenses in rate charges to customers. 14
The ratio of operating expense, excluding depreciation and income taxes, to total revenue was 58.2% for the nine months ended September 30, 2004, compared to 59.3% for the nine months ended September 30, 2003. Depreciation and amortization expense increased $374,000, or 14.2%, over the nine months ended September 30, 2003 to $3.0 million due to increases in our utility plant in service providing supply, treatment, storage and distribution of water. Income tax expense increased $113,000 due to higher profitability for the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003. Other Income, Net - ----------------- Our Allowance for Funds Used During Construction increased $91,000 as a result of the significant increase in our investment in utility plant for the first nine months of 2004 compared to the same period in 2003, as further discussed under "Liquidity and Capital Resources" below. Miscellaneous Income increased $145,000 primarily due to increased patronage income from CoBank of $130,000, which is related to the Company's issuance of an additional $25 million in First Mortgage Bonds in January 2003 to CoBank, a cooperative bank that distributes equity and cash income to its customer-owners. Interest Charges - ---------------- Interest charges increased $820,000, or 22.7%, over the nine months ended September 30, 2003, primarily due to interest related to the $25 million Series P First Mortgage Bond issued on January 31, 2003 and the $15.4 million Series Q First Mortgage Bond issued on December 1, 2003. The Series P Bond issuance replaced the Series L 8.03% $10 million bond and paid down our line of credit. Net Income - ---------- Our net income increased $111,000 for the nine months ended September 30, 2004, compared to the same period a year ago. The increase in net income for the nine months was less than expected after accounting for growth in customers and temporary rate increases placed in effect during the period primarily due to the combined impact of wetter than normal weather; the need for recovery of costs associated with investments in utility plant, including interest charges associated with the issuance of debt to finance additions to utility plant, in rates charged to water customers; and the increased operating expenses discussed above that are not fully reflected in the temporary rate increases. Our net income applicable to common stock increased by $178,000 as redemption premium costs of $54,000 associated with the buy-back of all 10,868 shares of our 7% Prior Preferred Stock on February 21, 2003 were reflected in the nine months ended September 30, 2003. Results of Operations - Analysis of Third Quarter of 2004 Compared to Third Quarter of 2003 - ---------------------------------------------------------------------------- Operating Revenues - ------------------ Revenues totaled $10.6 million for the quarter ended September 30, 2004, $1.4 million, or 14.9% above revenues for the quarter ended September 30, 2003 of $9.2 million. Water sales revenue increased 12.3% for the quarter ended September 30, 2004 over the corresponding period in 2003 primarily due to temporary rate increases placed into effect on April 6, 2004 of 6.98% and September 7, 2004 of 8.02% that together are designed to generate an additional 15% in gross water sales on an annual basis, pursuant to the Company's 2004 rate application described above. The remaining increase in operating revenues for the quarter ended September 30, 2004 is primarily due to additional revenues generated by wastewater and contract operations services. We realized 95.6% of our total revenue for the quarter ended September 30, 2004 from the sale of water. Operating Expenses - ------------------ Operating expenses, excluding depreciation and income taxes, increased $172,000, or 3.1%, to $5.6 million for the quarter ended September 30, 2004, compared to $5.5 million for the same period in 2003. The components of the increase in operating expenses for the quarter ended September 30, 2004 primarily included 15
increases in administrative expenses of $108,000, in purchased water expense of $63,000 and in repair and maintenance expense of $43,000. These increases were partially offset by a decrease in purchased power expense of $55,000, as treatment facilities were cut back to better match supply production with demand and utilizing minimum purchases under water supply agreements during the quarter ended September 30, 2004. Administration expenses increased approximately $108,000 for the quarter ended September 30, 2004, or 16.9%, due primarily to $137,000 related to engineering services incurred by our wastewater subsidiary and to the work involved with documenting internal controls to comply with the Sarbanes-Oxley Act. The engineering fees are charged back to developers under contract and the associated revenues have been reflected in our operating revenues under non-utility revenue. Administration expenses also increased due to an increase in training cost of $12,000 primarily associated with recently purchased software systems. These increases were partially offset by a reduction of $43,000 in related party expense due to our purchase of the office and shop complex in October 2003, which we had previously leased from White Clay Realty. Purchased water expense increased $63,000 due to a fluctuation in the timing of takes under our minimum contractual annual obligations. The overall increase in repair and maintenance expense of $43,000, or 15.1%, is primarily comprised of $15,000 for maintenance programs associated with recently purchased software systems, and $16,000 related to increases in prices charged for transportation fuels. Payroll and associated employee benefits expense increased $8,000, due to a $69,000 increase in medical insurance costs that was offset almost entirely by the capitalization of payroll costs associated with the development of data programs associated with the Company's customer information system. The ratio of operating expense, excluding depreciation and income taxes, to total revenue was 53.2% for the quarter ended September 30, 2004, compared to 59.2% for the quarter ended September 30, 2003. Other Income, Net - ----------------- Our Allowance for Funds Used During Construction decreased $61,000 as a result of a decrease in our investment in utility plant for the third quarter of 2004 compared to the same period in 2003, as further discussed under "Liquidity and Capital Resources" below. Interest Charges - ---------------- Interest charges increased $266,000, or 21.7%, over the quarter ended September 30, 2003, primarily due to interest related to the $15.4 million Series Q First Mortgage Bond issued on December 1, 2003. Net Income - ---------- Our net income increased $426,000 for the quarter ended September 30, 2004, compared to the same period a year ago. The increase in net income for the quarter was due to the combined impact of the two increases in rates placed in effect in April and September 2004 and a significant increase in operating income for our non-regulated wastewater subsidiary. In addition, we have continued efforts to control operating expenses during this period when wetter than normal weather conditions have inhibited the anticipated overall growth in water sales. 16
LIQUIDITY AND CAPITAL RESOURCES Our primary sources of liquidity for the nine months ended September 30, 2004 were $6.5 million provided by cash flow from operating activities and $17.2 million from financing activities, which includes $4.4 million in contributions and advances. Cash flow from financing activities also includes $12.8 million in proceeds from the issuance of the Series Q First Mortgage Bond (the Series Q Bond). The Series Q Bonds were issued December 1, 2003 as a tax-free bond through the Delaware Economic Development Authority ("DEDA"). The funds are held in an interest bearing account until such time as we invest in infrastructure previously approved by DEDA. Cash flow from operating activities is primarily provided by our utility operations, and is impacted by the timeliness and adequacy of rate increases and changes in water consumption as a result of year-to-year variations in weather conditions particularly during the summer. 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. We invested over $23.7 million in utility plant and equipment during the first nine months of 2004, a 65.0% increase from the $14.4 million invested in the same period in 2003. The increase in expenditure was primarily related to a significant effort to increase sources of supply and reliability of our systems in northern and southern New Castle County through full integration of our systems. Nearly $8.4 million was invested to place into service a 3 million gallon per day treatment facility and complete hydraulic improvements in New Castle County. With this effort, we are in position to certify that we have sufficient self supply to serve our customers as required by the Self Sufficiency Act passed by Delaware in 2003. In southern New Castle County we improved the reliability of our systems by investing $2.5 million in an elevated storage tank and additional supply to support expansion in this area. Another $1.2 million was invested in sources of supply and infrastructure to support the significant growth in other parts of Delaware for which we provide service. In 2004, we invested $1.3 million for new customer information and financial systems software. The customer information system will replace software developed by Artesian Water and modified over the last 25 years that has since become obsolete and difficult to maintain in light of technology advancements. In addition, we invested approximately $4.4 million in the relocation of mains as a result of highway relocations and our continued effort to replace or renew older mains to improve water quality and reliability to customers. At September 30, 2004, Artesian Water had lines of credit with two separate financial institutions totaling $40.0 million to meet its temporary cash requirements. These revolving credit facilities are unsecured. As of September 30, 2004, we had $28.8 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, 2004 the rate on these lines was 2.62%. All the facilities are reviewed annually by each bank for renewal. We expect that our available projected cash generated from operations and available bank credit lines will be sufficient to meet our financial obligations for the next twelve months. 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 expansion of service area, our customer growth, contract operations opportunities, the safety and dependability of our water supply, investment plans in 2004, revenues from temporary rate increases, plans to increase our wastewater treatment operations and other revenue streams less affected by weather, plans for Artesian Wastewater to apply for a CPCN to begin providing wastewater services as a regulated public utility, plans to file certification of sufficient sources of self-supply, our ability to obtain final approval on pending rate increase requests, our expected expenses for consulting and auditing fees related to Section 404 compliance work and other expected expenses, and our liquidity needs are 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 changes in weather, changes in our contractual obligations, changes in government policies, changes 17
in economic conditions, and other matters could cause results to differ materially from those in the forward-looking statements. The Company does not undertake to update any of the forward-looking statements included in the Quarterly Report on Form 10-Q except as required by law. ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are 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 terms of our First Mortgage Bonds, which have maturity dates ranging from 2007 to 2043. ITEM 4 - CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company's disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. The Company believes that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. (b) Change in Internal Control over Financial Reporting No change in the Company's internal control over financial reporting occurred during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 18
PART II - OTHER INFORMATION ITEM 1 - LEGAL PROCEEDINGS There are no material legal proceedings pending at this date. ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 31.1 Certification of Chief Executive Officer of the Registrant required by Rule 13a - 14 (a) under the Securities Act of 1934. 31.2 Certification of Chief Financial Officer of the Registrant required by Rule 13a - 14 (a) under the Securities Act of 1934. 32 Certification of Chief Executive Officer and Chief Financial Officer of the Registrant required by Rule 13a - 14 (b) under the Securities Act of 1934. (b) Reports on Form 8-K. A current report on Form 8-K dated September 24, 2004 was filed with the Securities and Exchange Commission on September 29, 2004 reporting a draw-down on the proceeds of our $15.4 million, 4.75%, 40-year Series Q First Mortgage Bonds. A current report on Form 8-K dated August 31, 2004 was filed with the Securities and Exchange Commission on September 2, 2004 reporting approval by the Delaware Public Service Commission to implement revised temporary rates in our pending rate case. 19
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. ARTESIAN RESOURCES CORPORATION Date: November 1, 2004 By: /s/ Dian C. Taylor ----------------------------- Dian C. Taylor, (Principal Executive Officer) Date: November 1, 2004 By: /s/ David B. Spacht -------------------------------------------- David B. Spacht, (Principal Financial and Accounting Officer) 20
INDEX TO EXHIBITS Exhibit Number Description -------------- ----------- 31.1 Certification of Chief Executive Officer of the Registrant required by Rule 13a - 14 (a) under the Securities Act of 1934. 31.2 Certification of Chief Financial Officer of the Registrant required by Rule 13a - 14 (a) under the Securities Act of 1934. 32 Certification of Chief Executive Officer and Chief Financial Officer of the Registrant required by Rule 13a - 14 (b) under the Securities Act of 1934. 21