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Home›Maximum revenue tariff›MIDDLESEX WATER CO Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)

MIDDLESEX WATER CO Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)

By Jacob Castillo
April 29, 2022
4
0
The following discussion and analysis should be read in conjunction with the
unaudited condensed consolidated financial statements of Middlesex Water Company
(Middlesex or the Company) included elsewhere herein and with the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2021.

Forward-Looking Statements
Certain statements contained in this periodic report and in the documents
incorporated by reference 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. The Company intends that these statements be covered
by the safe harbors created under those laws. They include, but are not limited
to statements as to:

-

the financial situation, performance, prospects and expected profits of the Company; –

strategic plans for growth;
-

the amount and timing of rate increases and other regulatory matters, including the recovery of certain costs recognized as regulatory assets; –

the Company’s expected cash requirements in the coming year and beyond and the sources and availability of funds to meet its cash requirements; –

expected customer rates, consumption volumes, service fees, revenues, margins,
expenses and operating results;
-

financial projections;
-

the expected amount of cash contributions to fund the Company’s pension plans, expected discount rates and rates of return on plan assets; –

the ability of the Company to pay dividends;
-

the Company's compliance with environmental laws and regulations and estimations
of the materiality of any related costs;
-

the safety and reliability of the Company’s equipment, facilities and operations; –

the Company’s plans to renew franchises and municipal consents in the territories it serves; –

trends; and
-

the availability and quality of our water supply.

These forward-looking statements are subject to risks, uncertainties and other
factors that could cause actual results to differ materially from future results
expressed or implied by the forward-looking statements. Important factors that
could cause actual results to differ materially from anticipated results and
outcomes include, but are not limited to:

-

effects of general economic conditions;
-

increases in competition for growth in non-franchised markets to be potentially
served by the Company;
-

ability of the Company to adequately control selected operating expenses which
are necessary to maintain safe and proper utility services, and which may be
beyond the Company's control;
-

availability of adequate supplies of water;
-

actions taken by government regulators, including decisions on rate increase
requests;
-

new or modified water quality standards and compliance with related regulatory
requirements;
-

variations in weather and other natural phenomena affecting utility operations; –

financial and operational risks associated with acquisitions and/or privatizations; –

acts of war or terrorism;
-

cyber - attacks;
-

changes in the pace of housing development;
-

availability and cost of capital resources;
-

the timely availability of materials and supplies for operations and critical infrastructure projects; –

impact of the novel coronavirus (COVID-19) pandemic; and –

other factors discussed elsewhere in this quarterly report.

Many of these factors are beyond the Company's ability to control or predict.
Given these uncertainties, readers are cautioned not to place undue reliance on
any forward-looking statements, which only speak to the Company's understanding
as of the date of this report. The Company does not undertake any obligation to
release publicly any revisions to these forward-looking statements to reflect
events or circumstances after the date of this report or to reflect the
occurrence of unanticipated events, except as may be required under applicable
securities laws.

                                       16

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For an additional discussion of factors that may affect the Company's business
and results of operations, see Item 1A. - Risk Factors in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2021.

Insight

Middlesex Water Company (Middlesex or the Company) has operated as a water
utility in New Jersey since 1897 and in Delaware through our wholly-owned
subsidiary, Tidewater Utilities, Inc. (Tidewater), since 1992. We are in the
business of collecting, treating and distributing water for domestic,
commercial, municipal, industrial and fire protection purposes. We operate water
and wastewater systems under contract for governmental entities and private
entities primarily in New Jersey and Delaware and also provide regulated
wastewater services in New Jersey. We are regulated by state public utility
commissions as to rates charged to customers for water and wastewater services,
as to the quality of water and wastewater services we provide and as to certain
other matters in the states in which our regulated subsidiaries operate. Only
our Utility Service Affiliates, Inc. (USA), Utility Service Affiliates (Perth
Amboy), Inc. (USA-PA) and White Marsh Environmental Services, Inc. (White Marsh)
subsidiaries are not regulated public utilities as related to rates and services
quality. All municipal or commercial entities whose utility operations are
managed by these entities however, are subject to environmental regulation at
the federal and state levels.

Our principal New Jersey water utility system (the Middlesex System) provides
water services to approximately 61,000 retail customers, primarily in central
New Jersey. The Middlesex System also provides water sales under contract to
municipalities in central New Jersey with a total population of over 0.2
million. Our Bayview system provides water services in Downe Township, New
Jersey. Our other New Jersey subsidiaries, Pinelands Water Company and Pinelands
Wastewater Company, provide water and wastewater services to approximately 2,500
customers in Southampton Township, New Jersey.

Our Delaware subsidiaries, Tidewater and Southern Shores Water Company, LLC,
provide water services to approximately 55,000 retail customers in New Castle,
Kent and Sussex Counties, Delaware. Tidewater's subsidiary, White Marsh,
services approximately 4,500 customers in Kent and Sussex Counties through
various operations and maintenance contracts.

USA-PA operates the water and wastewater systems for the City of Perth Amboy,
New Jersey (Perth Amboy) under a 10-year operations and maintenance contract
expiring in 2028. In addition to performing day-to day operations, USA-PA is
also responsible for emergency response and management of capital projects
funded by Perth Amboy.

USA operates the Borough of Avalon, New Jersey's (Avalon) water utility, sewer
utility and storm water system under a 10-year operations and maintenance
contract expiring in June 2022. USA participated in the public proposal process
for the Borough's procurement of a new contract and a decision on this proposal
is expected in the second quarter of 2022. In addition to performing day-to-day
service operations, USA is responsible for billing, collections, customer
service, emergency response and management of capital projects funded by Avalon.
USA operates the Borough of Highland Park, New Jersey's water and wastewater
systems under a 10-year operations and maintenance contract expiring in June
2030. Under a marketing agreement with HomeServe USA Corp. (HomeServe) expiring
in 2031, USA offers residential customers in New Jersey and Delaware water and
wastewater related services and home maintenance programs. HomeServe is a
leading national provider of such home maintenance service programs. USA
receives a service fee for the billing, cash collection and other administrative
functions associated with HomeServe's service contracts.

                                       17

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RECENT DEVELOPMENTS

Capital Construction Program - The Company's multi-year capital construction
program encompasses numerous projects designed to upgrade and replace utility
infrastructure as well as enhance the integrity and reliability of assets to
maintain and improve service for the current and future generations of water and
wastewater customers. The Company plans to invest approximately $90 million in
2022 in connection with projects that include, but are not limited to:
•

Construction of a facility to provide an enhanced treatment process at the
Company's largest New Jersey wellfield in South Plainfield to comply with new
state water quality regulations relative to poly- and perfluoroalkyl substances,
collectively referred to as PFAS, and integrate surge protection to mitigate
spikes in water pressures along with enhancements to corrosion control and
disinfection processes;
•

Replacement of approximately six miles of water mains including full main and
service line replacements, meter pit installations and fire hydrant replacements
in the Township of Woodbridge, New Jersey;
•

Upgrading our work and asset management computer system; •

Construction of two elevated water storage tanks in our Tidewater service territory; and •

Various other water main replacements and upgrades.

Regulatory Notice of Non-Compliance- In September 2021, the New Jersey
Department of Environmental Protection (NJDEP) issued a Notice of Non-Compliance
(Notice) to Middlesex based on self-reporting by Middlesex that the level of
Perfluorooctanoic Acid (PFOA) in water treated at its Park Avenue Wellfield
Treatment Plant in South Plainfield, New Jersey exceeded a recently promulgated
NJDEP standard effective in 2021. Neither the NJDEP nor Middlesex has
characterized this exceedance as an acute health threat. However, Middlesex was
required to notify its affected customers and complied in November 2021 as
required by the regulation. Further, the Notice required the Company to take any
action necessary to comply with the new standard by September 7, 2022.

The NJDEP standard for PFOA was developed based on a Health-based Maximum
Contaminant Level (MCL) of 14 parts per trillion (ppt). Although the United
States Environmental Protection Agency (USEPA) has not yet implemented a
regulation relative to PFOA, the water distributed from the Park Avenue
Wellfield Treatment Plant does meet the USEPA's current health advisory level of
70 ppt and would meet the NJDEP's pre-2021 standard guidance level of 40 ppt,
which was not a regulation. Construction of an enhanced treatment process at the
Park Avenue Wellfield Treatment Plant to comply with an anticipated NJDEP
standard, at a level which was unknown at that time, had already begun prior to
the regulation being enacted. Since completion is not expected until mid-2023,
in December 2021, the Company implemented an interim solution to meet the Notice
requirements. The Park Avenue Wellfield Treatment Plant was taken off-line and
alternate sources of supply have been obtained. The Company is in the process of
implementing an acceleration of a portion of the Park Avenue Wellfield treatment
upgrades in order to meet anticipated increases in the historical higher water
demand periods during the summer months. This is also intended to result in
compliance with the requirements of the Notice.

In November 2021, the Company was served with two PFOA-related class action
lawsuits seeking restitution for medical, water replacement and other claimed
related costs. These lawsuits are in the early stages of the legal process and
their ultimate resolution cannot be predicted at this time. The Company's
insurance provider has acknowledged coverage of potential liability which may
result from these lawsuits.

In January 2022, the Company filed a petition with the New Jersey Board of
Public Utilities (NJBPU) seeking to establish a regulatory asset and deferred
accounting treatment until its next base rate setting proceeding for all costs
associated with the interim solution to comply with the Notice.

While the Company believes monetary penalties are unlikely, the issuance of the
Notice does not preclude the State of New Jersey, or any of its agencies, from
initiating formal administrative and/or judicial enforcement action, including
assessment of penalties of up to $25,000 per day per offense if the Company is
not in compliance with the requirements of the Notice by September 7, 2022.

Rate and Regulatory Matters - In December 2021, Middlesex's petition to the
NJBPU seeking permission to increase its base water rates was concluded, based
on a negotiated settlement, resulting in an expected increase in annual
operating revenues of $27.7 million. The approved tariff rates were designed to
recover increased operating costs as well as a return on invested capital of
$513.5 million, based on an authorized return on common equity of 9.6%. The
increase is being implemented in two phases with $20.7 million of the increase
effective January 1, 2022 and the remaining $7.0 million effective January 1,
2023. As part of the negotiated settlement, the Purchased Water Adjustment
Clause (PWAC), which is a rate mechanism that allows for recovery of increased
purchased water costs between base rate case filings, was reset to zero.

In March 2022Middlesex has filed a petition with the NJBPU seeking approval to set its PWAC tariff rate to recover the additional costs of $3.7 million for the purchase of treated water from an unaffiliated regulated water utility regulated by the NJBPU. We cannot predict whether the NJBPU will ultimately approve, deny, or reduce the amount of our request.

Sale of Subsidiary - In January 2022, Middlesex closed on the Delaware Public
Service Commission (DEPSC) approved sale of 100% of the common stock of its
subsidiary Tidewater Environmental Services, Inc. (TESI) to Artesian Wastewater
Management, Inc. for $6.4 million in cash and other consideration, resulting in
a $5.2 million pre-tax gain. The Company will continue to own and operate its
non-regulated water and wastewater contract operations business in Delaware.

COVID-19 - On April 13, 2022, the United States Secretary of Health and Human
Services renewed the determination that a nationwide health emergency exists as
a result of the COVID-19 Pandemic. While the Company's operations and capital
construction program have not been materially disrupted to date from the
pandemic, the COVID-19 impact on economic conditions nationally continues to be
uncertain and could affect the Company's results of operations, financial
condition and liquidity in the future. In New Jersey, the declared COVID-19
State of Emergency ended on March 7, 2022. In Delaware, the declared COVID-19
State of Emergency Order ended in July 2021.

The NJBPU and the DEPSC have approved the tracking of COVID-19 related
incremental costs for potential recovery in customer rates in future rate
proceedings. Neither jurisdiction has established a timetable or definitive
formal procedures for seeking cost recovery. Since March 2020, the Company has
increased its allowance for doubtful accounts for expected increases in accounts
receivable write-offs due to the financial impact of COVID-19 on customers.
Since the ultimate rate treatment to be determined by the NJBPU regarding
incremental costs related to Covid-19 is not definitively known at this time,
the Company has not deferred any such costs. We will continue to monitor the
effects of COVID-19 and evaluate its impact on the Company's results of
operations, financial condition and liquidity.

                                       18

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Outlook

Our ability to increase operating income and net income is based significantly
on four factors: weather, adequate and timely rate relief, effective cost
management and customer growth. These factors are evident in comparison
discussions in the Results of Operations section below. Unfavorable weather
patterns may occur at any time, which can result in lower customer demand for
water. Our investments in system infrastructure continue to grow significantly
and our operating costs are anticipated to increase in 2022 in a variety of
categories. These factors, among others, may require the need to file requests
during 2022 for increases in customer rates.

An additional factor that we continue to actively monitor is the impact of new
variants of COVID-19 on the general economy, our suppliers and our workforce
(for further discussion of the impact of COVID-19 on the Company, see Recent
Developments, COVID-19 above).

Overall, organic residential customer growth in our Tidewater system is expected to be above historical averages. However, builders and developers are experiencing longer home sales closing cycles due to supply chain issues.

The Company has projected to spend approximately $229 million for the 2022-2024
capital investment program, including approximately $39 million for PFAS-related
treatment upgrades in the Middlesex System, $33 million on the RENEW Program,
which is our ongoing initiative to replace water mains in the Middlesex System,
$13 million for construction of elevated storage tanks in our Tidewater and
Middlesex Systems and $10 million for the rehabilitation and other improvements
associated with Middlesex's main field operations and inventory facilities.

Our profitable growth strategy focuses on the following key areas:

A non-controllable factor that may affect our outlook in 2021 is the pace at
which remediation of the COVID-19 pandemic continues to occur, and the related
impact on the regional and national economic recoveries. In addition, the New
Jersey SEO moratorium on customer service terminations remains in effect,
currently through June 30, 2021. For further discussion of the impact of
COVID-19 on the Company, see Recent Developments, COVID-19 above.

Organic residential customer growth in our Tidewater system is expected to continue at the 5% rate achieved in 2020, delaying any foreseeable need to seek an increase in base customer rates in 2021.

Our profitable growth strategy focuses on the following key areas:

•

Invest in projects, products and services that complement our core water and
wastewater competencies;
•

Timely and adequate recovery of infrastructure investments and other costs to
maintain service quality;
•

Prudent acquisitions from investors and municipally owned water and wastewater utilities; and •

Operation of municipal and industrial water and wastewater systems on a contract basis that meet our risk profile.

Operating results by segment

The discussion of the Company's operating results is on a consolidated basis and
includes significant factors by subsidiary. The Company has two operating
segments, Regulated and Non-Regulated. The operations of the Regulated segment
are subject to regulations promulgated by state public utility commissions as to
rates and level of service. Rates and level of service in the Non-Regulated
segment are subject to the terms of individually-negotiated and executed
contracts with municipal, industrial and other clients. Both segments are
subject to federal and state environmental, water and wastewater quality and
other associated legal and regulatory requirements.

The segments in the tables below include the following companies: Regulated-Middlesex, Tidewater, Pinelands, Southern Shores and TESI; Not regulated-UNITED STATES, UNITED STATES-PA, and White Marsh.

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Results of operations – Quarters ended March 31, 2022

                                                          (In Thousands)
                                                   Three Months Ended March 31,
                                        2022                                          2021
                                         Non-                                          Non-
                       Regulated       Regulated        Total        Regulated       Regulated        Total
Revenues              $    33,296     $     2,900     $  36,196     $    29,390     $     3,151     $  32,541
Operations and
maintenance
expenses                   17,179           1,960        19,139          16,249           2,107        18,356
Depreciation
expense                     5,563              59         5,622           4,774              58         4,832
Other taxes                 4,081              63         4,144           3,651              68         3,719
Gain on Sale Of
Subsidiary                  5,232               -         5,232               -               -             -
Operating income           11,705             818        12,523           4,716             918         5,634

Other income, net           1,702              54         1,756           1,979              59         2,038
Interest expense            1,850               -         1,850           1,738               -         1,738
Income taxes                   44             285           329          (1,283 )           310          (973 )
Net income            $    11,513     $       587     $  12,100     $     6,240     $       667     $   6,907


Operating Revenues

Operating revenue for the three months ended March 31, 2022 increased $3.7 million the same period in 2021 due to the following factors:

•

Middlesex System revenues increased $3.8 million due primarily to its approved
base rate increase effective January 1, 2022;
•

Tidewater System revenues increased $0.7 million due to additional customers and
a one-time customer credit refund issued in the first quarter of 2021, which
were partially offset by lower customer demand and lower new customer connection
fees;
•

The sale of our regulated Delaware wastewater subsidiary in January 2022 reduced
revenues by $0.6 million; and
•

Unregulated income has decreased $0.2 million due to the decrease in additional services provided under operating contracts.

Operating and maintenance expenses

Operating and maintenance expenses for the three months ended March 31, 2022
increased $0.8 million the same period in 2021 due to the following factors:

•

Increased weather-related main rupture activity in our Middlesex system during the winter months has resulted in $0.3 million additional non-labor costs; •

Labor costs increased $0.3 million due to higher overtime for Middlesex system
main breaks and wage increases;
•

Water treatment costs increased $0.3 million due to weather-driven changes in
water quality;
•

Expenses related to employee benefits decreased $0.4 million mainly due to lower service charges for actuarially determined pension plans; and •

All other categories of operating and maintenance expenses increased $0.3 million.

Depreciation

Depreciation expense for the three months ended March 31, 2022 increased $0.8
million from the same period in 2021 due to a higher level of utility plant in
service.

Other Taxes

Other taxes for the three months ended March 31, 2022 increased $0.4 million
from the same period in 2021 primarily due to higher revenue related taxes on
increased revenues in our Middlesex system.

Gain on sale of subsidiary

Middlesex acknowledged a $5.2 million capital gain on the sale of its regulated assets Delaware
wastewater treatment subsidiary in January 2022 (for details of the sale transaction, see Recent Developments, Sale of Subsidiary above).

                                       20

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Other income, net

Other income, net for the three months ended March 31, 2022 decreases $0.3 million compared to the same period in 2021 mainly attributable to $0.9 million of the Allowance for Funds used during construction due to a lower number of construction projects, partially offset by $0.6 million higher non-service benefits from pension plans determined by actuarial calculations.

Interest charges

Interest charges for the three months ended March 31, 2022 increased $0.1 million compared to the same period in 2021 due to the higher average outstanding short and long-term debt in 2022 compared to 2021.

Income taxes

Income taxes for the three months ended March 31, 2022 increased by $1.3 million
from the same period in 2021, primarily due to income taxes on the gain on the
sale of the subsidiary and higher pre-tax operating income. Partially offsetting
the taxes on the sales gain were higher income tax benefits associated with
increased repair expenditures on tangible property owned by Middlesex.

Net earnings and earnings per share

Net income for the three months ended March 31, 2022 increased $5.2 million as
compared with the same period in 2021. Basic earnings per share were $0.69 and
$0.39 for the three months ended March 31, 2022 and 2021, respectively. Diluted
earnings per share were $0.68 and $0.39 for the three months ended March 31,
2022 and 2021, respectively

Cash and capital resources

Operating cash flow

Cash flows from operations are largely based on four factors: weather, adequate
and timely rate increases, effective cost management and growth. The effect of
those factors on net income is discussed in "Results of Operations."

Operating cash flow

For the three months ended March 31, 2022cash flow from operating activities increased $4.5 million for $14.0 million. The increase in cash flow from operating activities is mainly due to the timing of payments to suppliers.

Cash flow investment

For the three months ended March 31, 2022, cash flows used in investing
activities decreased $8.5 million to $13.5 million. The decrease in cash flows
used in investing activities resulted from decreased utility plant expenditures
and cash received from the sale of Middlesex's regulated wastewater
subsidiary in January 2022 (for further discussion on the sales transaction, see
Recent Developments, Sale of Subsidiary above).

For more details on the Company’s future capital expenditures and anticipated sources of funding, see “Capital Expenditures and Commitments” below.

Cash flow financing

For the three months ended March 31, 2022, cash flows used in financing
activities increased $7.1 million to $0.7 million. The increase in cash flows
used in financing activities is due to a reduction in net short-term bank
borrowings partially offset by increased proceeds from the issuance of common
stock under the Middlesex Water Company Investment Plan (the Investment Plan).

Capital expenditures and commitments

To fund our capital program, we use internally generated funds, short-term and
long-term debt borrowings, proceeds from sales of common stock under the
Investment Plan and proceeds from sales offerings to the public of our common
stock. See below for a more detailed discussion regarding the funding of our
capital program.

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The capital investment program for 2022 is currently estimated at around $90 million. By March 31, 2022 we spent $17 million
and expect to incur approximately $73 million for capital projects for the remainder of 2022.

We currently project that we may expend approximately $139 million for capital
projects in 2023 and 2024. The actual amount and timing of capital expenditures
is dependent on the need for replacement of existing infrastructure, customer
growth, residential new home construction and sales, project scheduling and
continued refinement of project scope and costs and, could be impacted if new
variants of the COVID-19 pandemic arise and continue for an extended period of
time.

To pay for our capital program for the remainder of 2022, we plan on utilizing
some or all of the following:
•

Internally generated funds;
•

Short-term borrowings, as needed, through $140 million of lines of credit
established with three financial institutions. As of March 31, 2022, there was
$125.0 million of available credit under these lines (for further discussion on
Company lines of credit, see Note 6 - Short Term Borrowings);
•

Proceeds from the Delaware State Revolving Fund (SRF). SRF programs provide low
cost financing for projects that meet certain water quality and system
improvement;
•

Proceeds from the sale and issuance of First Mortgage Bonds in private placement
offerings; and
•

Proceeds from the company’s investment plan.

On September 1, 2021, the Company began offering shares of its common stock for
purchase at a 3% discount to participants in the Investment Plan. The discount
offering will continue until 200,000 shares are purchased at the discounted
price or August 1, 2022, whichever event occurs first.

In order to fully fund the ongoing large investment program in our utility plant
infrastructure and maintain a balanced capital structure for a regulated water
utility, Middlesex may offer for sale additional shares of its common stock. The
amount, the timing and the sales method of the common stock is dependent on the
timing of the construction expenditures, the level of additional debt financing
and financial market conditions. As previously approved by the NJBPU in 2019,
the Company is authorized to issue and sell up to 0.7 million shares of its
common stock in one or more transactions through December 31, 2022.

Recent Accounting Pronouncements – See Note 1 of the Notes to the Unaudited Condensed Consolidated Financial Statements for a discussion of recent accounting pronouncements and guidance.

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