Artesian Resources (ARTNA) 10-Q2021 Q2 Quarterly report

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.

Indicate by check mark whether the registrant has submitted electronically, every Interactive Data file required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and “emerging growth company” in Rule 12(b)-2 of the Exchange Act.

As of August 3, 2021, 8,519,681 shares of Class A Non-Voting Common Stock and 881,452 shares of Class B Common Stock were outstanding.

Statements in this Quarterly Report on Form 10-Q that express our "belief," "anticipation" or "expectation," as well as other statements that are not historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act, Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act and the Private Securities Litigation Reform Act of 1995.  Statements regarding specific and overall impacts of the COVID-19 global pandemic on our financial condition and results of operations, our goals, priorities, growth and expansion plans and expectation for our water and wastewater subsidiaries and non-regulated subsidiaries, customer base growth opportunities in Delaware and Cecil County, Maryland, our belief regarding our capacity to provide water services for the foreseeable future to our customers, our belief relating to our compliance and the cost to achieve compliance with relevant governmental regulations, our expectation of the timing of decisions by regulatory authorities, the impact of weather on our operations and the execution of our strategic initiatives, our expectation of the timing for construction on new projects, our expectation relating to the adoption of recent accounting pronouncements, contract operations opportunities, legal proceedings, our properties, deferred tax assets, adequacy of our available sources of financing, the expected recovery of expenses related to our long-term debt, our expectation to be in compliance with financial covenants in our debt instruments, our ability to refinance our debt as it comes due, our ability to adjust our debt level, interest rate, maturity schedule and structure, the timing and terms of renewals of our lines of credit, plans to increase our wastewater treatment operations, engineering services and other revenue streams less affected by weather, expected future contributions to our postretirement benefit plan, anticipated growth in our non-regulated division, the impact of recent acquisitions on our ability to expand and foster relationships, anticipated investments in certain of our facilities and systems and the sources of funding for such investments, and the sufficiency of internally generated funds and credit facilities to provide working capital 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.  Words such as "expects", "anticipates", "intends", "plans", "believes", "seeks", "estimates", "projects", "forecasts", "may", "should", variations of such words and similar expressions are intended to identify such forward-looking statements.  Certain factors as discussed under Item 1A -Risk Factors, in our Annual Report on Form 10-K for the year ended December 31, 2020, and this Quarterly Report on Form 10-Q for the quarter ended June 30, 2021, such as changes in weather, changes in our contractual obligations, changes in government policies, the timing and results of our rate requests, failure to receive regulatory approval, changes in economic and market conditions generally, and other matters could cause results to differ materially from those in the forward-looking statements.  Additionally, many of these risks and uncertainties are currently elevated by and may or will continue to be elevated by the COVID-19 pandemic.  While the Company may elect to update forward-looking statements, we specifically disclaim any obligation to do so and you should not rely on any forward-looking statement as a representation of the Company's views as of any date subsequent to the date of the filing of this Quarterly Report on Form 10-Q.

Our profitability is primarily attributable to the sale of water. Gross water sales composed 87.5% of total operating revenues for the six months ended June 30, 2021.  Our profitability is also attributed to the various contract operations, water, sewer and internal SLP Plans and other services we provide.  Water sales are subject to seasonal fluctuations, particularly during summer when water demand may vary with rainfall and temperature.  In the event 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. Our contract operations and other services provide a revenue stream that is not affected by changes in weather patterns.

Artesian Water, Artesian Water Maryland and Artesian Water Pennsylvania provide water service to residential, commercial, industrial, governmental, municipal and utility customers.  Increases in the number of customers contribute to increases, or help to offset any intermittent decreases, in our operating revenue.  As of June 30, 2021, the number of metered water customers in Delaware increased approximately 2.3% compared to June 30, 2020.  The number of metered water customers in Maryland increased approximately 1.5% compared to June 30, 2020.  The number of metered water customers in Pennsylvania remained consistent compared to June 30, 2020.  For the six months ended June 30, 2021, approximately 4.0 billion gallons of water were distributed in our Delaware systems and approximately 63.6 million gallons of water were distributed in our Maryland systems.

Our strategy is to increase customer growth, revenues, earnings and dividends by expanding our water, wastewater and SLP Plan services across the Delmarva Peninsula.  We remain focused on providing superior service to our customers and continuously seek ways to improve our efficiency and performance.  Our strategy has included a focus on building strategic partnerships with county governments, municipalities and developers.  By providing water and wastewater services, we believe we are positioned as the primary resource for developers and communities throughout the Delmarva Peninsula seeking to fill both needs simultaneously.  We believe we have a proven ability to acquire and integrate high growth, reputable entities, through which we have captured additional service territories that will serve as a base for future revenue.  We believe this experience presents a strong platform for further expansion and that our success to date also produces positive relationships and credibility with regulators, municipalities, developers and customers in both existing and prospective service areas.

In our regulated water division, our strategy is to focus on a wide spectrum of activities, which include strategic acquisitions of existing systems, expanding certificated service area, identifying new and dependable sources of supply, developing the wells, treatment plants and delivery systems to supply water to customers and educating customers on the wise use of water.  Our strategy includes focused efforts to expand through strategic acquisitions and in new regions added to our Delaware service territory over the last 10 years.  We plan to expand our regulated water service area in the Cecil County designated growth corridor and to expand our business through the design, construction, operation, management and acquisition of additional water systems.  The expansion of our exclusive franchise areas elsewhere in Maryland and the award of contracts will similarly enhance our operations within the state.

Our ability to develop partnerships with various county governments, municipalities and developers has provided a number of opportunities.  In the last four years, we completed seven acquisitions including asset purchase agreements with municipal and developer/homeowner association operated systems.  Some recent acquisitions are noted below.

On August 3, 2020, Artesian Water completed the purchase of substantially all of the water system operating assets from the City of Delaware City, a Delaware municipality, or Delaware City, including the right to provide water service to Delaware City’s existing customers.  The total purchase price was $2.1 million.  Artesian Water had previously acquired the water assets of an area annexed by Delaware City, known as Fort DuPont, which was earmarked for growth and expansion of Delaware City.

On April 2, 2020, Artesian Water completed its purchase of substantially all of the operating assets of the water system of the Town of Frankford, a Delaware municipality, or Frankford, including the right to provide water service to Frankford’s existing customers, or the Frankford Water System.  Pursuant to the terms of the agreement, Frankford transferred to Artesian Water all of Frankford’s right, title and interest in and to all of the plant and equipment, associated real property, contracts, easements and permits possessed by Frankford at closing related to the Frankford Water System.  The total purchase price was $3.6 million.

We believe that Delaware's generally lower cost of living in the region, availability of development sites in relatively close proximity to the Atlantic Ocean in Sussex County, and attractive financing rates for construction and mortgages have resulted, and will continue to result, in increases to our customer base.  Delaware’s lower property and income tax rate make it an attractive region for new home development and retirement communities.  Substantial portions of Delaware currently are not served by a public water system, which could also assist in an increase to our customer base as systems are added.

In our regulated wastewater division, we foresee significant growth opportunities and will continue to seek strategic partnerships and relationships with developers and governmental agencies to complement existing agreements for the provision of wastewater service on the Delmarva Peninsula. Artesian Wastewater plans to utilize our larger regional wastewater facilities to expand service areas to new customers while transitioning our smaller treatment facilities into regional pump stations in order to gain additional efficiencies in the treatment and disposal of wastewater. We believe this will reduce operational costs at the smaller treatment facilities in the future because they will be converted from treatment and disposal plants to pump stations to assist with transitioning the flow of wastewater from one regional facility to another.

On September 27, 2016, Artesian Wastewater entered into a wastewater services agreement with a large industrial customer for Artesian Wastewater to provide treatment and disposal services for sanitary wastewater discharged from this customer’s properties located in Sussex County, Delaware upon completion of a pipeline to transfer the sanitary wastewater.  The pipeline was completed in the second quarter of 2017.  The transfer of sanitary wastewater began in the second quarter of 2019.  On January 27, 2017, Artesian Wastewater entered into a second wastewater agreement with this customer for Artesian Wastewater to provide disposal services for approximately 1.5 mgd of treated industrial process wastewater upon completion of an approximately eight mile pipeline that will transfer the wastewater from this customer’s properties to a 90 million gallon storage lagoon at Artesian’s Sussex Regional Recharge Facility.  We will use the reclaimed wastewater for spray irrigation on agricultural land in the area.  We received an operations permit in March 2020.  We began operating this facility in late June 2021, shortly after the industrial customer received its process wastewater treatment operating permit.  This agreement includes a required minimum wastewater flow.  Pursuant to a settlement agreement, for the calendar year 2021 only, the minimum required volume of wastewater will be prorated on a seven month basis beginning June 1, 2021 and ending December 31, 2021.

The general need for increased capital investment in our water and wastewater systems is due to a combination of population growth, more protective water quality standards and aging infrastructure.  Our planned and budgeted capital improvements over the next three years includes projects for water infrastructure improvements and expansion in both Delaware and Maryland and wastewater infrastructure improvements and expansion in Delaware.  The DEPSC and MDPSC have generally recognized the operating and capital costs associated with these improvements in setting water and wastewater rates for current customers and capacity charges for new customers.

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.

Revenues totaled $22.6 million for the three months ended June 30, 2021, $0.8 million, or 3.7%, more than revenues for the three months ended June 30, 2020. Water sales revenue increased $0.7 million, or 3.4%, for the three months ended June 30, 2021 from the corresponding period in 2020, primarily due to an increase in non-residential consumption revenue, partially offset by a decrease in residential consumption revenue.  In addition, fixed fee revenue increased related to customer growth.  We realized 89.0% and 89.3% of our total operating revenue for the three months ended June 30, 2021 and June 30, 2020, respectively, from the sale of water.

Other utility operating revenue increased slightly for the three months ended June 30, 2021 compared to the three months ended June 30, 2020.  The increase in wastewater revenue from customer growth was offset by a decrease in industrial wastewater service revenue resulting from an adjustment, pursuant to a settlement agreement, of approximately $0.4 million related to the minimum required volume of wastewater under contract.

Non-utility operating revenue increased approximately $0.1 million, or 10.6%, for the three months ended June 30, 2021 compared to the three months ended June 30, 2020.  The increase is primarily due to an increase in contract service revenue related to a contract for the design and construction of wastewater infrastructure and an increase in Service Line Protection Plan revenue.

Operating expenses, excluding depreciation and income taxes, increased $0.6 million, or 4.9%, for the three months ended June 30, 2021, compared to the same period in 2020, primarily related to an increase in utility operating expenses and non-utility operating expenses of $0.4 million and $0.1 million, respectively.

Non-utility operating expenses increased $0.1 million, or 17.6%, for the three months ended June 30, 2021 compared to the three months ended June 30, 2020, primarily due to an increase in payroll and employee benefit costs, an increase in costs associated with the wastewater infrastructure design and construction contract, and an increase in plumbing services related to Service Line Protection Plan repairs.

The ratio of operating expense, excluding depreciation and income taxes, to total revenue was 53.0% for the three months ended June 30, 2021, compared to 52.4% for the three months ended June 30, 2020.

Depreciation and amortization expense increased $0.3 million, or 10.5%, primarily due to continued investment in utility plant providing supply, treatment, storage and distribution of water to customers and service to our wastewater customers.

Our net income applicable to common stock decreased $0.1 million, or 1.3%, primarily due to a decrease in net operating income.

Revenues totaled $43.3 million for the six months ended June 30, 2021, $1.6 million, or 3.9%, more than revenues for the six months ended June 30, 2020. Water sales revenue increased $1.1 million, or 3.0%, for the six months ended June 30, 2021 from the corresponding period in 2020, primarily due to an increase in residential and non-residential consumption revenue.  In addition, fixed fee revenue increased related to customer growth.  We realized 87.6% and 88.4% of our total operating revenue for the six months ended June 30, 2021 and June 30, 2020, respectively, from the sale of water.

Other utility operating revenue increased approximately $0.2 million, or 10.2%, for the six months ended June 30, 2021 compared to the six months ended June 30, 2020.  The increase is primarily due to an increase in wastewater revenue from customer growth, partially offset by a decrease in industrial wastewater service revenue resulting from an adjustment, pursuant to a settlement agreement, of approximately $0.4 million related to the minimum required volume of wastewater under contract.

Non-utility operating revenue increased approximately $0.3 million, or 12.6%, for the six months ended June 30, 2021 compared to the six months ended June 30, 2020.  The increase is primarily due to an increase in contract service revenue related to a contract for the design and construction of wastewater infrastructure and an increase in Service Line Protection Plan revenue. 

Operating expenses, excluding depreciation and income taxes, increased $1.2 million, or 5.1%, for the six months ended June 30, 2021, compared to the same period in 2020, primarily related to an increase in utility operating expenses and non-utility operating expenses of $0.8 million and $0.3 million, respectively.

Non-utility operating expenses increased $0.3 million, or 21.5%, for the six months ended June 30, 2021 compared to the six months ended June 30, 2020, primarily due to an increase in costs associated with the wastewater infrastructure design and construction contract, an increase in payroll and employee benefit costs and an increase in plumbing services related to Service Line Protection Plan repairs.

The ratio of operating expense, excluding depreciation and income taxes, to total revenue was 55.2% for the six months ended June 30, 2021, compared to 54.6% for the six months ended June 30, 2020.

Depreciation and amortization expense increased $0.5 million, or 10.0%, primarily due to continued investment in utility plant providing supply, treatment, storage and distribution of water to customers and service to our wastewater customers.

Other income, net increased $0.1 million, primarily due to an increase in miscellaneous income of $0.3 million related to an increase in the annual patronage refund from CoBank, ACB.  The primary refund calculation for both 2021 and 2020 was based on 0.8% of the average loan balance outstanding.  In addition, a special patronage distribution based on 0.165% and 0.1% of the average loan balance outstanding was refunded in March 2021 and March 2020, respectively.  Allowance for funds used during construction, or AFUDC, decreased $0.1 million as a result of lower long-term construction activity subject to AFUDC for the six months ended June 30, 2021 compared to the same period in 2020.

Our net income applicable to common stock increased $0.1 million, or 0.8%, primarily related to an increase in other income, net.

Our primary sources of liquidity for the six months ended June 30, 2021 were $16.5 million of cash provided by operating activities, $9.8 million in net contributions and advances from developers, $1.7 million from the issuance of long-term debt and $0.9 million in net proceeds from the issuance of common stock.  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 ensure that 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 will continue to borrow on available lines of credit in order to satisfy current liquidity needs.  In addition, the Company has a long history of paying regular quarterly dividends as approved by our Board of Directors using net cash from operating activities.

The primary focus of our investments is to continue to provide high quality reliable service to our growing service territory.  Capital expenditures during the first six months of 2021 were $22.1 million compared to $20.6 million during the same period in 2020.  During the first six months of 2021, we invested approximately $11.2 million for our rehabilitation program for transmission and distribution facilities by replacing aging or deteriorating mains and for installing new mains.  We invested $4.5 million to enhance or improve existing treatment facilities and replace aging wells and pumping equipment to better serve our customers.  We invested $0.7 million for equipment purchases, computer hardware and software upgrades and transportation equipment.  Developers financed $2.9 million for the installation of water mains and hydrants in 2021 compared to $2.2 million in 2020.  We invested $0.5 million to upgrade and automate our meter reading equipment.  We invested approximately $1.4 million in mandatory utility plant expenditures due to governmental highway projects, which required the relocation of water service mains in addition to facility improvements and upgrades.  We invested $0.9 million in wastewater projects in Delaware.

At June 30, 2021, Artesian Water had a $20 million line of credit with CoBank, ACB, or CoBank, that allows for the financing of operations for Artesian Water, with up to $10 million of this line available for the operations of Artesian Water Maryland. As of June 30, 2021, there was $2.0 million of available funds under this line of credit.  The interest rate for borrowings under this line allows the Company to select either LIBOR plus 1.50% or a weekly variable rate established by CoBank; the Company has historically used the weekly variable interest rate.  The term of this line of credit expires on July 30, 2022. Artesian Water expects to renew this line of credit.

Payments for unconditional purchase obligations reflect minimum water purchase obligations based on rates that are subject to change under two interconnection agreements with the Chester Water Authority.  One agreement that is currently in effect has a “take or pay” clause requiring us to purchase 3 million gallons per day, which expires on December 31, 2021.  The other agreement is effective from January 1, 2022 through December 31, 2026, and has a “take or pay” clause requiring us to purchase water on a step down schedule through July 5, 2022, thereafter requiring us to purchase 0.5 million gallons per day.  In addition, payments for unconditional purchase obligations reflect minimum water purchase obligations based on a contract rate under our interconnection agreement with the Town of North East, which expires June 26, 2024.

In April 2021, Artesian Water entered into a 3-year agreement with Worldwide Industries Corporation effective July 1, 2021 to paint elevated water storage tanks.  Pursuant to the 3-year agreement, the total expenditure for the three years is $1.2 million.

Information concerning our implementation and the impact of recent accounting pronouncements issued by the FASB is included in the notes to our 2020 consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2020 and also in the notes to our unaudited condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q.  We did not adopt any accounting policy in the first six months of 2021 that had a material impact on our financial condition, liquidity or results of operations.

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report.  Based upon this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report were effective in providing reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (2) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.  In addition, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report were effective to achieve the foregoing objectives. A control system cannot provide absolute assurance, however, that the objectives of the control 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.

No change in our internal control over financial reporting occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Periodically, we are involved in other proceedings or litigation arising in the ordinary course of business.  We do not believe that the ultimate resolution of these matters will materially affect our business, financial position or results of operations.  However, we cannot ensure that we will prevail in any litigation and, regardless of the outcome, may incur significant litigation expense and may have significant diversion of management attention.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2020, which could materially affect our business, financial condition or future results. There have been no material changes to the risk factors described in such Annual Report on Form 10-K.

Not applicable.