YORK WATER CO - Quarter Report: 2017 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2017

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 001-34245

(Exact name of registrant as specified in its charter)

Registrant's telephone number, including area code (717) 845-3601

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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 12b-2 of the Exchange Act (check one):

Large accelerated filer ☐	Accelerated filer ý		Non-accelerated filer ☐
			(Do not check if a smaller reporting company)
Small Reporting company ☐		Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

TABLE OF CONTENTS

 

 

THE YORK WATER COMPANY

PART I - FINANCIAL INFORMATION

Item 1.     Financial Statements

THE YORK WATER COMPANY

Balance Sheets (Unaudited)

(In thousands of dollars, except per share amounts)

The accompanying notes are an integral part of these statements.

THE YORK WATER COMPANY

Balance Sheets (Unaudited)

(In thousands of dollars, except per share amounts)

The accompanying notes are an integral part of these statements.

THE YORK WATER COMPANY

Statements of Income (Unaudited)

(In thousands of dollars, except per share amounts)

The accompanying notes are an integral part of these statements.

THE YORK WATER COMPANY

Statements of Common Stockholders' Equity (Unaudited)

(In thousands of dollars, except per share amounts)

For the Periods Ended June 30, 2017 and 2016

The accompanying notes are an integral part of these statements.

THE YORK WATER COMPANY

Statements of Cash Flows (Unaudited)

(In thousands of dollars, except per share amounts)

The accompanying notes are an integral part of these statements.

THE YORK WATER COMPANY

 

Notes to Interim Financial Statements

(In thousands of dollars, except per share amounts)

 

1.	Basis of Presentation

 

The interim financial statements are unaudited but, in the opinion of management, reflect all adjustments, consisting of only normal recurring accruals, necessary for a fair presentation of results for such periods.  Because the financial statements cover an interim period, they do not include all disclosures and notes normally provided in annual financial statements, and therefore, should be read in conjunction with the financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2016.

 

Operating results for the three and six month periods ended June 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.

2.	Common Stock and Earnings Per Share

 

Net income of $2,935 and $2,847 for the three months ended June 30, 2017 and 2016, respectively, and $5,516 and $5,333 for the six months ended June 30, 2017 and 2016 respectively, is used to calculate both basic and diluted earnings per share.  Basic earnings per share is based on the weighted average number of common shares outstanding.  Diluted earnings per share is based on the weighted average number of common shares outstanding plus potentially dilutive shares.  The dilutive effect of employee stock-based compensation is included in the computation of diluted earnings per share and is calculated using the treasury stock method and expected proceeds upon exercise or issuance of the stock-based compensation.  The following table summarizes the shares used in computing basic and diluted earnings per share.

On March 11, 2013, the Board of Directors, or the Board, authorized a share repurchase program granting the Company authority to repurchase up to 1,200,000 shares of the Company's common stock from time to time.  The stock repurchase program has no specific end date and the Company may repurchase shares in the open market or through privately negotiated transactions.  The Company may suspend or discontinue the repurchase program at any time.  During the three and six months ended June 30, 2017, the Company repurchased 12,900 and 37,229 shares respectively. No shares were repurchased during the three or six months ended June 30, 2016. As of June 30, 2017, 618,004 shares remain authorized for repurchase.

 

3.	Commitments

The Company has committed to capital expenditures of approximately $11,598 for an additional raw water pumping station and force main, of which $3,490 remains to be incurred as of June 30, 2017. The Company may make additional commitments for this project in 2017.

During its triennial testing completed in 2016, the Company determined it exceeded the action level for lead at the customer's tap as established by the Lead and Copper Rule, or LCR, issued by the U.S. Environmental Protection Agency.  The rule allows the Company to have five samples of the 50 high-risk homes tested exceed the action level of 15 parts per billion, or PPB.  The testing found that six properties with lead service lines, all built before 1935, exceeded the action level, and the reported exceedance amount was 1 PPB.  The Company has determined that only 3% of the company-owned service lines in the system are lead.  The Company will be required, per the LCR, to engage in more frequent testing for lead, public education, and annually replace 7% of the remaining company-owned lead service lines in its distribution system.  The Company has announced plans to perform in excess of the required actions.  Specifically, the Company will provide the affected customers with a free water test and a 200 gallon per month credit to flush their line in order to reduce any lead content until their lead service line has been replaced. The cost of the water tests and flushing credits was $4 for the three months ended June 30, 2017 and $11 for the six months ended June 30, 2017. Additional amounts for water tests and flushing credits are not expected to have a material impact on the financial position of the Company over the remaining three and a half years. 

In addition, the Company has entered into a consent order agreement with the Pennsylvania Department of Environmental Protection.  Under the agreement, the Company has committed to exceed the LCR replacement schedule by replacing all of the remaining company-owned lead service lines within the next three and a half years.  The cost for these service line replacements was approximately $1,030 through June 30, 2017 and is included in utility plant.  Additional replacements are expected to be approximately $1,600 over the next three and a half years, and will be integrated into the Company's annual capital budgets. 

Finally, the Company has been granted approval by the PPUC to modify its tariff to include the cost of the replacement of lead customer-owned service lines that are discovered when the Company replaces its lead service lines over the next three and a half years, and to include the cost of the annual replacement of up to 400 lead customer-owned service lines whenever they are discovered, regardless of the material used for the Company-owned service line over nine years.  The tariff modification allows the Company to replace customer-owned service lines at its own initial cost.  The Company will record the costs as a regulatory asset to be recovered in future base rates to customers, over a reasonable period of at least four but not more than six years.  The cost for the customer-owned lead service line replacements under the four-year tariff modification was approximately $93 through June 30, 2017 and is included as a regulatory asset.  Additional replacements are expected to be approximately $130 under the four-year tariff modification, assuming the average percentage of customer-owned lead service lines that were replaced when company-owned lead service lines were replaced through June 30, 2017 remains consistent over the entire replacement period.  The Company is unable to predict how many lead customer-owned service lines are in use, and, therefore, its current estimate of $1,040 for replacements under the nine-year tariff modification is subject to adjustment as more facts become available.

 

4.

Pensions

 

Components of Net Periodic Pension Cost

Employer Contributions

 

The Company previously disclosed in its financial statements for the year ended December 31, 2016 that it expected to contribute $2,300 to its pension plans in 2017.  For the six months ended June 30, 2017, contributions of $1,150 had been made.  The Company expects to contribute the remaining $1,150 over the final two quarters of 2017.

 

5.

Debt

 

In the second quarter of 2017, the Company renewed its $13,000 and $11,000 committed lines of credit and extended the maturity date of each to May 2019.  In addition, the Company renewed its $7,500 line of credit and extended the maturity date to June 2018.

 

6.	Interest Rate Swap Agreement

The Company is exposed to certain risks relating to its ongoing business operations.  The primary risk managed by using derivative instruments is interest rate risk.  The Company utilizes an interest rate swap agreement to effectively convert the Company's $12,000 variable-rate debt issue to a fixed rate.  Interest rate swaps are contracts in which a series of interest rate cash flows are exchanged over a prescribed period.  The notional amount on which the interest payments are based ($12,000) is not exchanged.  The interest rate swap provides that the Company pays the counterparty a fixed interest rate of 3.16% on the notional amount of $12,000.  In exchange, the counterparty pays the Company a variable interest rate based on 59% of the U.S. Dollar one-month LIBOR rate on the notional amount.  The intent is for the variable rate received from the swap counterparty to approximate the variable rate the Company pays to bondholders on its variable rate debt issue, resulting in a fixed rate being paid to the swap counterparty and reducing the Company's interest rate risk.  The Company's net payment rate on the swap was 2.53% and 2.88% during the three months that ended June 30, 2017 and 2016, respectively, and 2.59% and 2.84% for the six months that ended June 30, 2017 and 2016, respectively.

 

The interest rate swap agreement is classified as a financial derivative used for non-trading activities.  The accounting standards regarding accounting for derivatives and hedging activities require companies to recognize all derivative instruments as either assets or liabilities at fair value on the balance sheet.  In accordance with the standards, the interest rate swap is recorded on the balance sheet in other deferred credits at fair value (see Note 7).

The Company uses regulatory accounting treatment rather than hedge accounting to defer the unrealized gains and losses on its interest rate swap.  Instead of the effective portion being recorded as other comprehensive income or loss and the ineffective portion being recognized in earnings using the cash flow hedge accounting rules provided by the derivative accounting standards, the entire unrealized swap value is recorded as a regulatory asset.  Based on current ratemaking treatment, the Company expects the unrealized gains and losses to be recognized in rates as a component of interest expense as the swap settlements occur.  Swap settlements are recorded in the income statement with the hedged item as interest expense.  Swap settlements resulted in the reclassification from regulatory assets to interest expense $76 and $86 during the three month period ended June 30, 2017 and 2016, respectively, and $155 and $173 for the six month period ended June 30, 2017 and 2016, respectively. The overall swap result was a loss of $120 and $334 for the three months ended June 30, 2017 and 2016, respectively, and a loss of $129 and $843 for the six months ended June 30, 2017 and 2016, respectively. The Company expects to reclassify $281 from regulatory assets to interest expense as a result of swap settlements over the next 12 months.

 

The interest rate swap agreement contains provisions that require the Company to maintain a credit rating of at least BBB- with Standard & Poor's.  If the Company's rating were to fall below this rating, it would be in violation of these provisions, and the counterparty to the derivative could request immediate payment if the derivative was in a liability position.  On April 21, 2017, Standard & Poor's affirmed the Company's credit rating at A-, with a stable outlook and adequate liquidity.  The Company's interest rate swap was in a liability position as of June 30, 2017.  If a violation due to credit rating, or some other default provision, were triggered on June 30, 2017, the Company would have been required to pay the counterparty approximately $2,401.

 

The interest rate swap will expire on October 1, 2029.  Other than the interest rate swap, the Company has no other derivative instruments.

 

7.	Fair Value Measurements

 

The accounting standards regarding fair value measurements establish a fair value hierarchy which indicates the extent to which inputs used in measuring fair value are observable in the market.  Level 1 inputs include quoted prices for identical instruments and are the most observable.  Level 2 inputs include quoted prices for similar assets and observable inputs such as interest rates, commodity rates and yield curves.  Level 3 inputs are not observable in the market and include management's own judgments about the assumptions market participants would use in pricing the asset or liability.

 

The Company has recorded its interest rate swap liability at fair value in accordance with the standards.  The liability is recorded under the caption "Other deferred credits" on the balance sheet.  The table below illustrates the fair value of the interest rate swap as of the end of the reporting period.

 

 

Fair values are measured as the present value of all expected future cash flows based on the LIBOR-based swap yield curve as of the date of the valuation.  These inputs to this calculation are deemed to be Level 2 inputs.  The balance sheet carrying value reflects the Company's credit quality as of June 30, 2017.  The rate used in discounting all prospective cash flows anticipated to be made under this swap reflects a representation of the yield to maturity for 30-year debt on utilities rated A- as of June 30, 2017.  The use of the Company's credit rating resulted in a reduction in the fair value of the swap liability of $138 as of June 30, 2017.  The fair value of the swap reflecting the Company's credit quality as of December 31, 2016 is shown in the table below.

 

 

The carrying amount of current assets and liabilities that are considered financial instruments approximates fair value as of the dates presented.  The Company's total long-term debt, with a carrying value of $90,973 at June 30, 2017, and $87,488 at December 31, 2016, had an estimated fair value of approximately $103,000 and $99,000, respectively.  The estimated fair value of debt was calculated using a discounted cash flow technique that incorporates a market interest yield curve with adjustments for duration and risk profile.  These inputs to this calculation are deemed to be Level 2 inputs.  The Company recognized its credit rating in determining the yield curve, and did not factor in third party credit enhancements including bond insurance on the 2006 York County Industrial Development Authority issue and the letter of credit on the 2008 Pennsylvania Economic Development Financing Authority Series A issue.

Customers' advances for construction and notes receivable had carrying values at June 30, 2017 of $7,483 and $255, respectively.  At December 31, 2016, customers' advances for construction and notes receivable had carrying values of $7,102 and $255, respectively.  The relative fair values of these amounts cannot be accurately estimated since the timing of future payment streams is dependent upon several factors, including new customer connections, customer consumption levels and future rate increases.

 

8.	Income Taxes

 

The Company filed for a change in accounting method under the Internal Revenue Service tangible property regulations effective in 2014.  Under the change in accounting method, the Company is permitted to deduct the costs of certain asset improvements that were previously being capitalized and depreciated for tax purposes as an expense on its income tax return.  This ongoing deduction results in a reduction in the effective income tax rate, a net reduction in income tax expense, and a reduction in the amount of income taxes currently payable.  It also results in increases to deferred tax liabilities and regulatory assets representing the appropriate book and tax basis difference on capital additions.   As a result, the Company's effective tax rate was 31.8% and  34.2% for the three months ended June 30, 2017 and 2016, respectively, and 29.7% and 34.4% for the six months ended June 30, 2017 and 2016, respectively.  The effective tax rate will vary depending on the level of eligible asset improvements that are placed in service each period, which level was higher during the first six months of 2017 as compared to the first six months of 2016.

 

9.	Acquisitions

 

On January 6, 2017, the Company completed the acquisition of the water assets of Stockham's Village Mobile Home Park in Adams County, Pennsylvania.  The Company began operating the existing system through an interconnection with its current distribution system on January 9, 2017.  The acquisition resulted in the addition of approximately 80 new water customers with purchase price and acquisition costs of approximately $24. The purchase price and acquisition costs were more than the depreciated original cost of the assets.  The Company recorded an acquisition adjustment of approximately $17 and will seek approval from the Pennsylvania Public Utility Commission, or PPUC, to amortize the acquisition adjustment over the remaining life of the acquired assets.

On February 23, 2017, the Company completed the acquisition of the wastewater collection assets of West York Borough in York County, Pennsylvania.  The Company began operating the existing collection facilities on February 27, 2017.  The acquisition resulted in the addition of approximately 1,700 wastewater customers, representing more than 2,200 units, with purchase price and acquisition costs of approximately $448. The purchase price and acquisition costs were more than the depreciated original cost of the assets.  The Company recorded an acquisition adjustment of approximately $358 and will seek approval from the PPUC to amortize the acquisition adjustment over the remaining life of the acquired assets.

The result of these acquisitions has been immaterial to total Company results.

 

10.	Stock-Based Compensation

The restricted stock awards provide the grantee with the rights of a shareholder, including the right to receive dividends and to vote such shares, but not the right to sell or otherwise transfer the shares during the restriction period.  As a result, the awards are included in common shares outstanding on the balance sheet.  Restricted stock awards result in compensation expense valued at the fair market value of the stock on the date of the grant and are amortized ratably over the restriction period.

 

The following tables summarize the stock grant amounts and activity for the six months ended June 30, 2017.

 

	Number of Shares		Grant Date Weighted Average Fair Value
Nonvested at beginning of the period	660		$37.20
Granted	1,505		$38.00
Vested	(711)		$38.00
Forfeited	-		-
Nonvested at end of the period	1,454		$37.64

 

For the three months ended June 30, 2017, the statement of income includes $32 of stock-based compensation and related recognized tax benefits of $13. For the six months ended June 30, 2017, the statement of income includes $34 of stock-based compensation and related recognized tax benefits of $14. The total fair value of the shares vested in the six months ended June 30, 2017 was $27. Total stock-based compensation related to nonvested awards not yet recognized is $47 which will be recognized over the next three years.

 

11.	Rate Matters

 

From time to time, the Company files applications for rate increases with the PPUC and is granted rate relief as a result of such requests.  Most recently, the PPUC authorized an increase in rates effective February 28, 2014.

The PPUC permits water utilities to collect a distribution system improvement charge, or DSIC.  The DSIC allows the Company to add a charge to customers' bills for qualified replacement costs of certain infrastructure without submitting a rate filing.  This surcharge mechanism typically adjusts periodically based on additional qualified capital expenditures completed or anticipated in a future period.  The DSIC is capped at 5% of base rates, and is reset to zero when new base rates that reflect the costs of those additions become effective or when a utility's earnings exceed a regulatory benchmark. During its most recent quarterly reporting period, the Company's earnings were below the regulatory benchmark and the Company began recognizing DSIC in June 2017 for bills rendered after July 1, 2017 that included June consumption.  The DSIC provided revenues of $62 for the three and six months ended June 30, 2017 and $0 for the three and six months ended June 30, 2016.

12.	Impact of Recent Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers.  This ASU supersedes the revenue recognition requirements in Accounting Standards Codification 605—Revenue Recognition and most industry-specific guidance throughout the Codification.  The standard requires that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.  In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, deferring the effective date of this amendment for public companies by one year to fiscal years beginning after December 15, 2017.  Early adoption is permitted for fiscal years beginning after December 15, 2016, the original effective date.  The standard permits the use of either a retrospective or cumulative effect transition method.  The Company has not yet selected a transition method and is in the process of assessing the impact of the adoption of the standard on its financial position, results of operations and cash flows.  Based on its evaluation of ASU 2014-09 to date, which is  still ongoing, the Company does not expect it to have a material impact on its results of operations or cash flows in the periods after adoption.  This evaluation will be updated if contributions in aid of construction currently not in revenues are determined to be in the scope of the ASU.  Under ASU 2014-09, revenue is recognized as control transfers to the customer.  As such, revenue for the Company's contracts is generally from a single performance obligation that will be recognized at a point in time.  This is consistent with the revenue recognition model the Company currently uses for its contracts.  The Company will comply with the new disclosure requirements included in ASU 2014-09 which will have a significant impact on disclosures upon adoption.  The Company will complete its assessment of the expected impact of adoption, including selecting a transition method for adoption, in 2017, and continue to evaluate ASU 2014-09 through the date of adoption including the impact of adoption if contributions in aid of construction are determined to be in scope.

Forward-looking Statements

Certain statements contained in this report on Form 10-Q constitute "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933.  Words such as "may," "should," "believe," "anticipate," "estimate," "expect," "intend," "plan" and similar expressions are intended to identify forward-looking statements.  These forward-looking statements include certain information relating to the Company's business strategy; statements including, but not limited to:

The forward-looking statements in this report reflect what the Company currently anticipates will happen.  What actually happens could differ materially from what it currently anticipates will happen.  The Company does not intend to make a public announcement when forward-looking statements in this report are no longer accurate, whether as a result of new information, what actually happens in the future or for any other reason.  Important matters that may affect what will actually happen include, but are not limited to: