ARTESIAN RESOURCES CORP - Quarter Report: 2002 September (Form 10-Q)

FORM 10-Q

          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.

Part I - Financial Information
Item I - Financial Statements

          The unaudited consolidated financial statements of Artesian Resources Corporation and its wholly-owned subsidiaries (the Company or Artesian Resources), including its principal operating company, Artesian Water Company, Inc. (Artesian Water), presented herein have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and note disclosures prescribed by accounting principles generally accepted in the United States of America. These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2001, included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001. The accompanying consolidated financial statements have not been audited by independent accountants in accordance with generally accepted auditing standards and, in the opinion of management such consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary to fairly summarize the Company's financial position and results of operations. The results of operations for the interim periods may not be indicative of the results that may be expected for the entire year due to certain factors, such as developments in our current rate proceeding, competitive market pressures, material changes in demand from larger customers, changes in weather, changes in government policies, and changes in economic conditions.

          Certain expenses are recoverable through rates, without a return on investment, and are deferred and amortized during future periods using various methods as permitted by the Delaware Public Service Commission PSC ("Delaware PSC"). Expenses related to rate proceedings are amortized on a straight-line basis over a period of 2 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, comprise:

          The office building and shop complex utilized by Artesian Water are leased at an average annual rental of $180,000 from a partnership, White Clay Realty, in which certain of Artesian Resources' officers and directors are a partner or the beneficiary of a partner (Dian C. Taylor and John R. Eisenbrey, Jr.). The current rental of $180,000 is below market. The current lease may expire at the end of 2002, as certain of the partners of White Clay Realty who are not related to Artesian Resources contend that the option to extend the lease was not effectively exercised. Management does not necessarily agree with this contention, however, a special committee of the Board of Directors, composed entirely of outside directors not related to White Clay Realty, has been formed and authorized to evaluate all options, including the lease or purchase of the office building and complex belonging to White Clay Realty as well as the lease or purchase of other facilities belonging to third parties. By statute, Artesian Water has the power of eminent domain, whereby Artesian Water can compel a property owner to sell a property to Artesian Water for fair market value as determined by a court of law.

          Unaudited expenses associated with related party transactions are as follows:

          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 potentially dilutive effect of employee stock options. The following table summarizes the shares used in computing basic and diluted net income per share:

          Equity per common share was $19.71 and $16.63 at September 30, 2002 and 2001, respectively. These amounts were computed by dividing common stockholders' equity, excluding preferred stock, by the number of shares of common stock outstanding on September 30, 2002 and 2001, respectively.

          In October 2002, the FASB issued Statement No. 147, Acquisitions of Certain Financial Institutions. This statement provides guidance on the accounting for the acquisition of a financial institution. This statement has no applicability to Artesian Water Company, Inc.

          In June 2002, the FASB issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This statement nullifies EITF 94-3 which addressed this subject. The statement requires recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred. Our adoption of this statement will not have a material impact on our financial condition or results of operation.

          In April 2002, the FASB issued Statement No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections. Statement No. 145 eliminates accounting treatment described in Statements 4 and 64 related to Extinguishment of Debt and amends Statement 13 regarding the use of sale - lease back accounting. Our adoption of this statement will not have a material impact on our financial condition or results of operation.

          In August 2001, the FASB issued Statement No. 143, Accounting for Asset Retirement Obligations. Statement No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Statement No. 143 requires recognition of a liability at fair value and an increase to the carrying value of the related asset for any retirement obligation. This amount would then be amortized over the life of the asset. The liability would be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows. This statement is effective June 2003. Our adoption of this statement will not have a material impact on our financial condition or results of operations.

          On April 2, 2002, Artesian Water filed a rate increase application with the Delaware PSC to request a rate increase of 23.1%, or approximately $7.5 million, on an annualized basis. On June 17, 2002, we filed a supplemental application reducing our requested increase to 19.0%, or approximately $6.4 million on an annualized basis. On June 6, 2002, both the City of Wilmington and General Motors were granted permission to intervene in our rate increase application. The City of Wilmington is challenging the approval of a new industrial rate classification for water service to a General Motors facility that has received water service from both the City of Wilmington and Artesian Water. General Motors petitioned to intervene to protect their interest with regard to the City of Wilmington's intervention. On June 1, 2002, Artesian Water placed temporary rates into effect,60 days from the filing date, June 1, 2002, up to the statutory limit of $2.5 million on an annualized basis, under bond until the Delaware PSC decides the level of permanent rates. Hearings regarding Artesian Water's rate increase request were held on October 30 and October 31, 2002 before a Hearing Examiner. Briefing and a decision will follow. On October 30, 2002, during those evidentiary hearings the Company reduced its requested rate increase to $4.8 million on an annualized basis. As of November 2, 2002, we are permitted to extend our temporary rates up to $4.8 million, on an annualized basis, subject to refund. We have not yet determined when or if we will implement the new rates.

          On June 6, 2002, the Company completed the sale of 500,000 shares of Class A Non-Voting Common Stock. The net proceeds of approximately $14.9 million were used to reduce borrowing on Artesian Water's lines of credit.

Overview

          Artesian Resources is a non-operating holding Company whose income is derived from the earnings of its four wholly-owned subsidiary companies and its one-third interest in AquaStructure Delaware, LLC, or AquaStructure, whose primary activity is marketing wastewater services. Artesian Water, our principal subsidiary, is the oldest and largest regulated public water utility in the State of Delaware and has been providing water within the state since 1905. We distribute and sell water to residential, commercial, industrial, governmental, municipal and utility customers throughout Delaware. As of September 30, 2002, we had approximately 67,700 metered customers and served a population of approximately 220,000, representing approximately 27% of Delaware's total population.

          The Delaware Public Service Commission, or Delaware PSC, regulates Artesian Water's rate charges for water service, the issuance of Certificates of Public Convenience and Necessity, the sale and issuance of securities by Artesian Water, and other matters. We periodically seek and receive rate increases to cover the cost of increased expenses, due to additional investments in utility plant and equipment and other costs of doing business. Increases in customers served by Artesian Water also contribute to increases in our operating revenues, although such increases have been offset slightly by reductions in customers' individual usage. We continue our efforts to contain expenses and improve efficiencies that contribute to increases in our operating income. Our business is also subject to seasonal fluctuations and the effects of weather.

          We realized 97.2% and 97.6% of our total revenue in the quarter ended September 2002 and the first nine months of 2002 from the sale of water. Total revenues increased $513,000, or 5.7%, and $1,967,000, or 8.2%, for the quarter ended September 30, 2002 and the nine months ended September 30, 2002 compared to the quarter ended September 30, 2001 and the first nine months of 2001. The increase for both periods was primarily due to a growth in the number of customers served, rate increases approved by the Delaware PSC, effective February 13, 2001 and July 1, 2001, and implementation of temporary rates effective June 1, 2002 related to a rate increase request filed April 2, 2002. In Delaware, utilities are permitted to place rates into effect on a temporary basis pending completion of a rate increase proceeding. If such rates are found to be in excess of rates the Commission finds to be appropriate, the utility must refund the portion found in excess to customers with interest.

          We filed an application with the Delaware PSC on December 5, 2000, to increase rates for water service for all of Artesian Water's customers. A temporary rate increase, calculated to increase annualized revenues by $2.5 million, was approved by the Delaware PSC and placed into effect on February 3, 2001. If such rates are found to be in excess of rates the Delaware PSC finds to be appropriate, the utility must refund the portion found in excess to customers with interest. We received final approval, in Delaware PSC Docket 00-647 on June 19, 2001, to increase rates up to a total annualized increase in revenues of $3.7 million, or $1.2 million more than permitted under temporary rates. The approval was the result of a stipulated settlement reached by the Delaware PSC Staff and Division of Public Advocate. The increase in revenues for the various customer classes will not consistently match changes in consumption levels for the class primarily due to our use of a multiple rate block structure. This structure charges different rates for different levels of consumption. In addition, rate increases are distributed among the rate blocks and service charges through a cost of service analysis and may not reflect, on an individual class or charge basis, the overall increase in rates approved by the Delaware PSC.

          On April 2, 2002, Artesian Water filed a rate increase application with the Delaware PSC to request a rate increase of 23.1%, or approximately $7.5 million, on an annualized basis. On June 17, 2002, we filed a supplemental application reducing our requested increase to 19.0%, or approximately $6.4 million on an annualized basis. On June 6, 2002, both the City of Wilmington and General Motors were granted permission by the Hearing Examiner to intervene in our rate increase application. The City of Wilmington is challenging the approval of a new industrial rate classification for water service to a General Motors facility that has received water service from both the City of Wilmington and Artesian Water. General Motors petitioned to intervene to protect their interest with regard to the City of Wilmington's intervention. On June 1, 2002, Artesian Water placed temporary rates into effect, 60 days from the filing date, June 1, 2002, up to the statutory limit of $2.5 million on an annualized basis, under bond until the Delaware PSC decides the level of permanent rates. Hearings regarding Artesian Water's rate increase request were held on October 30 and October 31, 2002 before a Hearing Examiner. Briefing and a decision will follow. On October 30, 2002, during those evidentiary hearings the Company reduced its requested rate increase to $4.8 million on an annualized basis. As of November 2, 2002, we are permitted to extend our temporary rates up to $4.8 million, on an annualized basis, subject to refund. We have not yet determined when or if we will implement the new rates.

          By Executive Order on August 2, 2002, Governor Minner implemented mandatory water use restrictions in Northern New Castle County in light of continuing drought conditions. These mandatory restrictions primarily affect our customers- outside water use. Mandatory restrictions were lifted on October 11, 2002. The Governor had previously declared a drought warning on March 5, 2002 and requested voluntary conservation. We believe that the voluntary restrictions result in a lower than anticipated demand during the recent hot dry weather conditions. The mandatory water use restrictions resulted in decreases in water use by our customers in September and October.

          The State of Delaware passed legislation in 2000 requiring water utilities to use licensed operators. This provided the opportunity for Artesian Water to pursue contract management opportunities with other water providers as an additional source of revenue. Artesian Water was looking to expand and market its expertise in the water industry, while generating a more stable source of revenue which was not subject to fluctuations in weather and other outside influences. The Contract Service Revenue portion of Other Utility Operating Revenue increased $17,000 for the quarter ended September 30, 2002, over the same period last year, and $83,000 for the nine months ended September 30, 2002, over the same period last year.

          In addition, Artesian Wastewater Management, our non-regulated subsidiary, provides wastewater management and operations services for several wastewater treatment plants in Delaware. These services provide us with another stable source of revenue and are outside of the regulatory environment. Non-Utility Operating Revenue - Wastewater Services increased $77,000 for the quarter ended September 30, 2002, over the same period last year, and $106,000 for the nine months ended September 30, 2002, over the same period last year.

          Operating and maintenance expenses, excluding depreciation and taxes, increased $249,000 for the quarter ended September 30, 2002, and $1,091,000 for the nine months ended September 30, 2002, over comparable periods ended September 30, 2001. An increase in payroll and benefits of $300,000 for the quarter and $603,000 for the nine months ended September 30, 2002, due to additional positions, wage increases and bonuses, contributed to the increase in operating and maintenance expenses. In addition, due to the increased use of temporary and outside consulting services, administration expenses increased $308,000 for the nine months ended September 30, 2002. An offset to these increases was a decrease in purchased water expense of $167,000 for the nine months ended September 30, 2002. This decrease is due to the waiver of minimum takes by the Chester Water Authority due to drought conditions coupled with reduced demand on our system.

          Due to capital additions, depreciation and amortization expense increased $147,000, or 19.9% for the quarter ended September 30, 2002 and $301,000, or 13.7% for the nine months ended September 30, 2002, when compared to the same period in 2001. Income tax expense increased $75,000, or 8.0% and $332,000, or 19.3% for the quarter and the nine months ended September 30, 2002, as a result of increased profitability.

          Interest charges decreased $86,000, or 7.3%, over the quarter ended September 30, 2002, and decreased $85,000 or 2.5% for the first nine months of 2002, when compared to the quarter ended September 2001 and the first nine months of 2001. This can be primarily attributed to lower interest rates charged for short-term financing.

          For the quarter and nine months ended September 30, 2002, our net income applicable to common stock increased $73,000 and $366,000 respectively when compared to the same period in 2001. The increase in net income was predominantly due to rate increases authorized in 2001 and 2002 and continued customer growth.

          Our primary sources of liquidity for the quarter ended September 30, 2002 were $14.9 million from the proceeds from the issuance of 500,000 shares of common stock and $3.2 million provided by cash flow from operating activities. Cash flow from operating activities was, for the most part, provided by our utility operations, and was positively impacted by the timeliness and adequacy of rate increases.

          The office building and shop complex utilized by Artesian Water are leased at an average annual rental of $180,000 from a partnership, White Clay Realty, in which certain of Artesian Resources' officers and directors are a partner or the beneficiary of a partner (Dian C. Taylor and John R. Eisenbrey, Jr.). The current rental of $180,000 is below market. The current lease may expire at the end of 2002, as certain of the partners of White Clay Realty, who are not related to Artesian Resources contend that the option to extend the lease was not effectively exercised. Management does not necessarily agree with this contention, however, a special committee of the Board of Directors, composed entirely of outside directors not related to White Clay Realty, has been formed and authorized to evaluate all options, including the lease or purchase of the office building and complex belonging to White Clay Realty as well as the lease or purchase of other facilities belonging to third parties. By statute, Artesian Water has the power of eminent domain, whereby Artesian Water can compel a property owner to sell a property to Artesian Water for fair market value as determined by a court of law.

          At September 30, 2002, 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, 2002, we had $21.6 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% and at September 30, 2002 was 2.79 %. 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.

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 rate application and the effects of the mandatory water use restrictionsthe initiation of temporary rates, our investment plans in 2002 and whether we will conduct a debt offering, 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 developments in our current rate proceeding, competitive market pressures, material changes in demand from larger customers, changes in weather, changes in government policies, changes in economic conditions, and other matters listed under the heading Risk Factors in our Registration Statement on Form S-2 (File No. 333-87864), could cause results to differ materially from those in the forward-looking statements. The CompanyWe do does not undertake to update any of the forward-inglooking statements included in the Quarterly Report on Form 10-Q.

           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. Our 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 2003 to 2020.

           An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of November 4, 2002 was conducted under the supervision and with the participation of our management, including our chief executive officer and chief financial officer. Based on that evaluation, our management, including our chief executive officer and chief financial officer, concluded that our disclosure controls and procedures were effective as of November 4, 2002. There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to November 4, 2002.

          Not applicable.

          Not applicable.

          Not applicable.

          Not applicable.

          Not applicable.

         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.

Exhibit 99.1

ARTESIAN RESOURCES CORPORATION

FORM OF OFFICER CERTIFICATION REQUIRED BY SECTION 906 OF
THE SARBANES-OXLEY ACT