Not applicable.
None.
The Company owns two impounding dams located in York and Springfield Townships adjoining the Borough of Jacobus to the south. The lower dam, the Lake Williams Impounding Dam, creates a reservoir covering approximately 165 acres containing about 870 million gallons of water. The upper dam, the Lake Redman Impounding Dam, creates a reservoir covering approximately 290 acres containing about 1.3 billion gallons of water.
In addition to the two impounding dams, the Company owns a 15-mile pipeline from the Susquehanna River to Lake Redman that provides access to a supply of an additional 12.0 million gallons of water per day.
The Company also owns three satellite water systems in Adams County, Pennsylvania. The Carroll Valley Water System consists of two groundwater wells capable of providing a safe yield of approximately 100,000 gallons per day with a current average daily consumption of 16,000 gallons per day. The Western Cumberland Water System consists of three groundwater wells capable of providing a safe yield of 144,000 gallons per day with a current average daily consumption of 20,000 gallons per day. The Eastern Cumberland Water System consists of two groundwater wells capable of providing a safe yield of 122,000 gallons per day with a current average daily consumption of 29,000 gallons per day.
As of December 31, 2018, the Company's present average daily availability was 35.4 million gallons, and daily consumption was approximately 19.5 million gallons.
The Company's main pumping station is located in Spring Garden Township on the south branch of the Codorus Creek about four miles downstream from the Company's lower impounding dam. The pumping station presently houses pumping equipment consisting of three electrically driven centrifugal pumps and two diesel-engine driven centrifugal pumps with a combined pumping capacity of 68.0 million gallons per day. The pumping capacity is more than double peak requirements and is designed to provide an ample safety margin in the event of pump or power failure. A large diesel backup generator is installed to provide power to the pumps in the event of an emergency. The untreated water is pumped approximately two miles to the filtration plant through pipes owned by the Company.
The Susquehanna River Pumping Station is located on the western shore of the Susquehanna River several miles south of Wrightsville, PA. The pumping station is equipped with three Floway Vertical Turbine pumps rated at 6 million gallons per day each. The pumping station pumps water from the Susquehanna River approximately 15 miles through a combination of 30 inch and 36 inch ductile iron main to the Company’s upper impounding dam, located at Lake Redman.
In 2018, the new Lake Redman Pumping Station, located in York Township adjacent to Lake Redman, was put into service. The pumping station is designed to provide a redundant source with the capacity to pump 20 million gallons per day of untreated water through a company-owned 36 inch force main approximately 3.5 miles to the filtration plant, meeting the Company’s daily consumption needs.
The Company's water filtration plant is located in Spring Garden Township about one-half mile south of the City of York. Water at this plant is filtered through twelve dual media filters having a rated capacity of 39.0 million gallons per day, or MGD, with a maximum supply of 42.0 MGD for short periods if necessary. Based on an average daily consumption in 2018 of approximately 19.5 million gallons, the Company believes the pumping and filtering facilities are adequate to meet present and anticipated demands.
The Company’s sediment recycling facility is located adjacent to its water filtration plant. This state of the art facility employs cutting edge technology to remove fine, suspended solids from untreated water. The Company estimates that through this energy-efficient, environmentally friendly process, approximately 600 tons of sediment will be removed annually, thereby improving the quality of the Codorus Creek watershed.
The Company’s two wastewater treatment facilities are located in East Manchester and Lower Windsor Townships. The two wastewater treatment plants are each small, packaged, extended aeration activated sludge facilities with a combined average daily flow capacity of 167,000 gallons. With a projected maximum daily demand of 77,000 gallons, the plants’ flow paths offer both capacity and operational redundancy for maintenance, high flow events, and potential growth.
The distribution system of the Company has approximately 980 miles of water main lines which range in diameter from 2 inches to 36 inches. The distribution system includes 31 booster stations and 34 standpipes and reservoirs capable of storing approximately 58.1 million gallons of potable water. All booster stations are equipped with at least two pumps for protection in case of mechanical failure. Following a deliberate study of customer demand and pumping capacity, the Company installed standby generators at all critical booster stations to provide an alternate energy source or emergency power in the event of an electric utility interruption.
The three wastewater collection systems of the Company have a combined approximate 95,000 feet of 6 inch and 8 inch gravity collection mains and 5,000 feet of 6 inch pressure force main along with three sewage pumping stations each rated at 80 gallons per minute.
The Company's distribution center and material and supplies warehouse are located in Springettsbury Township, and are composed of three one-story concrete block buildings aggregating 30,680 square feet.
The administrative and executive offices of the Company are located in one three-story and one two-story brick and masonry buildings, containing a total of approximately 21,861 square feet, in the City of York, Pennsylvania.
All of the Company's properties described above are held in fee by the Company. There are no material encumbrances on such properties.
In 1976, the Company entered into a Joint Use and Park Management Agreement with York County under which the Company licensed use of certain of its lands and waters for public park purposes for a period of 50 years. Under the agreement, York County has agreed not to erect a dam upstream on the East Branch of the Codorus Creek or otherwise obstruct the flow of the creek.
There are no material legal proceedings involving the Company.
Not applicable.
PART II
| Item 5. | Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. |
Market Information
The common stock of The York Water Company is traded on the NASDAQ Global Select Market under the symbol YORW.
Shareholders of record (excluding individual participants in securities positions listings) as of December 31, 2018 numbered approximately 1,999.
Securities Authorized for Issuance under Equity Compensation Plans
The information required by this item with respect to securities authorized for issuance under equity compensation plans is set forth in Part III, Item 12 of this Annual Report.
Purchases of Equity Securities by the Company
The Company did not repurchase any of its securities during the fourth quarter of 2018.
| Item 6. | Selected Financial Data. |
Not applicable.
| Item 7. | Management's Discussion and Analysis of Financial Condition and Results of Operations. |
(All dollar amounts are stated in thousands of dollars.)
Overview
The York Water Company (the “Company”) is the oldest investor-owned water utility in the United States, operated continuously since 1816. The Company also operates three wastewater collection systems and two wastewater treatment systems. The Company is a purely regulated water and wastewater utility. Profitability is largely dependent on water revenues. Due to the size of the Company and the limited geographic diversity of its service territory, weather conditions, particularly rainfall, economic, and market conditions can have an adverse effect on revenues. While the economy in general continued to improve, market conditions were volatile. The Company experienced decreased revenues in 2018 compared to 2017 as a result of giving back to customers the benefit of tax reform and lower per capita consumption, which were partially offset by revenues from the distribution system improvement charge, or DSIC, an increase in the number of customers served, and the West York Borough wastewater acquisition.
The Company’s business does not require large amounts of working capital and is not dependent on any single customer or a very few customers for a material portion of its business. In 2018, operating revenue was derived from the following sources and in the following percentages: residential, 65%; commercial and industrial, 28%; and other, 7% which is primarily from the provision for fire service, but includes other water and wastewater service-related income. The diverse customer mix helps to reduce volatility in consumption.
The Company seeks to grow revenues by increasing the volume of water sold through increases in the number of customers served, making timely and prudent investments in infrastructure replacements, expansion and improvements, and timely filing for rate increases. The Company continuously looks for acquisition and expansion opportunities both within and outside its current service territory as well as through contractual services and bulk water supply. The Company’s wastewater business provides additional opportunities to expand.
The Company has entered into agreements with several municipalities to provide sewer billing and collection services. The Company also has a service line protection program on a targeted basis. The Company continues to review and consider opportunities to expand both initiatives to further diversify the business.
In addition to increasing revenue, the Company consistently focuses on minimizing costs without sacrificing water quality or customer service. Paperless billing, expanding online services, negotiation of favorable electric, banking and other costs, as well as taking advantage of the Tax Cuts and Jobs Act of 2017, or the 2017 Tax Act, and the IRS tangible property regulations, or TPR, are examples of the Company’s recent efforts to minimize costs.
Performance Measures
Company management uses financial measures including operating revenues, net income, earnings per share and return on equity to evaluate its financial performance. Additional statistical measures including number of customers, customer complaint rate, annual customer rates and the efficiency ratio are used to evaluate performance quality. These measures are calculated on a regular basis and compared with historical information, budget and the other publicly-traded water and wastewater companies.
The Company’s performance in 2018 was strong under the above measures. Although operating revenues declined slightly in 2018 compared to 2017, the cause of the decline was primarily due to reduced revenue to offset the benefit of the lower income tax rate pursuant to the 2017 Tax Act which will be returned to customers. This was partially offset by the collection of a DSIC and increases in the number of customers. Other net expenses were higher in 2018, primarily due to a decreased allowance for funds used during construction. The Company incurred lower income taxes primarily due to a higher volume of assets improvements eligible for the tax benefit under the IRS TPR and the full impact of the 2017 Tax Act. The overall effect was an increase in net income in 2018 over 2017 of 3.1% and a return on year end common equity of 10.6%, slightly lower than the 2017 result of 10.9% but consistent with the five-year historical average of 10.6%.
The efficiency ratio, which is calculated as net income divided by revenues, is used by management to evaluate its ability to control expenses. Over the five previous years, the Company’s ratio averaged 25.2%. In 2018, the ratio was higher than the average at 27.6% due primarily to lower income taxes than are included in the historical average. Management is confident that its ratio will compare favorably to that of its peers. Management continues to look for ways to decrease expenses and increase efficiency as well as to file for rate increases promptly when needed.
2018 Compared with 2017
Net income for 2018 was $13,376, an increase of $402, or 3.1%, from net income of $12,974 for 2017. The primary contributing factors to the increase were lower income taxes, which were partially offset by increased operating expenses and a decreased allowance for funds used during construction.
Operating revenues for the year decreased $152, or 0.3%, from $48,589 for 2017 to $48,437 for 2018. The Company reduced revenue by $1,600 for the year by recording a regulatory liability for the benefit of the lower tax rate effective January 1, 2018 resulting from the enactment of the 2017 Tax Act, which it has agreed to give back to customers as part of its recently approved PPUC rate order, including the gross-up of revenue necessary to return the effect of the temporary tax difference. Total per capita consumption for 2018 was approximately 1.0% lower than 2017. The decreased revenues were partially offset by revenues from the DSIC of $1,072 and the 2017 West York Borough wastewater acquisition of $126. Growth in the water customer base also added to revenues. The average number of water customers served in 2018 increased as compared to 2017 by 671 customers, from 67,061 to 67,732 customers. The average number of wastewater customers served in 2018 increased as compared to 2017 period by 279 customers, from 2,012 to 2,291 customers, due to the acquisition. The Company expects revenues for 2019 to increase due to an increase in rates effective March 1, 2019, and the continued increase in the number of water and wastewater customers from acquisitions and growth within the Company’s service territory. Other regulatory actions and weather patterns could impact results.
Operating expenses for 2018 increased $1,024, or 4.1%, from $24,896 for 2017 to $25,920 for 2018. The increase was primarily due to higher expenses of approximately $280 for distribution system maintenance, $241 for depreciation, and $217 for wages and employee benefits. Also adding to the increase were higher expenses of $82 for information technology, $77 for West York Borough wastewater operating expenses, $64 for purchased power, $56 for water treatment, and $48 for a consulting engagement. Other expenses increased by a net of $190. The increase was partially offset by lower expenses of approximately $142 for health insurance, $49 for legal expenses due to the absence of expenses for a tariff modification and lead disclosure, and $40 for bad debts. In 2019, the Company expects depreciation expense to continue to rise due to additional investment in utility plant, and other expenses to increase at a moderate rate as costs to treat water and to maintain and extend the distribution system continue to rise.
Interest on debt for 2018 increased $161, or 3.0%, from $5,348 for 2017 to $5,509 for 2018. The increase was primarily due to interest on line of credit borrowings. The average debt outstanding under the lines of credit was $7,206 for 2018 and $3,132 for 2017. The weighted average interest rate on the lines of credit was 3.20% for 2018 and 1.76% for 2017. Interest expense for 2019 is expected to be slightly lower due to the refinancing of 10.17% and 9.60% Senior Notes with 4.54% Senior Notes.
Allowance for funds used during construction decreased $635, from $864 for 2017 to $229 in 2018, due to a planned lower volume of eligible construction. Eligible 2017 construction expenditures included an investment in an additional raw water pumping station and force main project. Allowance for funds used during construction for 2019 is expected to increase based on a projected increase in the amount of eligible construction.
Other income (expenses), net for 2018 reflects decreased expenses of $387 as compared to 2017. Lower retirement expenses of approximately $184 due primarily to an increase in the discount rate, lower charitable contributions of $139, and higher earnings on life insurance policies of $37 were the primary reasons for the decrease. Other expenses decreased by a net of $27. For 2019, other income (expenses) will be largely determined by the change in market returns and discount rates for retirement programs and related assets.
Income taxes for 2018 decreased $2,052, or 45.2%, compared to 2017 due to the effects of the 2017 Tax Act, and a higher volume of asset improvements eligible for the tax benefit under the IRS TPR. The Company’s effective tax rate was 15.7% for 2018 and 25.9% for 2017. The Company's effective tax rate for 2019 will largely be determined by the level of eligible asset improvements expensed for tax purposes that would have been capitalized for tax purposes prior to the implementation of the TPR.
Rate Matters
See Note 10 to the Company’s financial statements included herein for a discussion of its rate matters.
Effective January 1, 2019 the Company’s tariff included a DSIC on revenues of 4.82%. The DSIC reset to zero when new base rates took effect on March 1, 2019.
The benefit from the implementation of the IRS TPR impacts the rate matters of the Company. The most recent rate order took into account the lower income taxes which resulted from the implementation of the IRS TPR, as well as the lower income taxes from the 2017 Tax Act, effectively reducing the amount of revenue required and lowering the Company’s rate increase.
Acquisitions and Growth
See Note 2 to the Company’s financial statements included herein for a discussion of completed acquisitions included in financial results.
On October 8, 2013, the Company signed an agreement to purchase the wastewater collection and treatment assets of SYC WWTP, L.P. in Shrewsbury and Springfield Townships, York County, Pennsylvania. Completion of the acquisition is contingent upon receiving approval from all required regulatory authorities. Closing is expected in 2019, at which time the Company will add approximately 30 commercial and industrial wastewater customers.
On October 25, 2018, the Company signed an agreement to purchase the wastewater collection assets of the Jacobus Borough Sewer Authority in York County, Pennsylvania. Completion of the acquisition is contingent upon receiving approval from all required regulatory authorities. Closing is expected in the third quarter of 2019 at which time the Company will add approximately 700 wastewater customers. These wastewater customers are currently water customers of the Company.
On December 28, 2018, the Company signed an agreement to purchase the wastewater collection and treatment assets of Felton Borough in York County Pennsylvania. Completion of the acquisition is contingent upon receiving approval from all required regulatory authorities. Closing is expected in 2019 at which time the Company will add approximately 130 wastewater customers.
On March 4, 2019, the Company signed an agreement to purchase the wastewater collection assets of West Manheim Township in York County, Pennsylvania. Completion of the acquisition is contingent upon receiving approval from all required regulatory authorities. Closing is expected in the first quarter of 2020 at which time the Company will add approximately 1,800 wastewater customers. These wastewater customers are currently water customers of the Company.
In total, these acquisitions are expected to be immaterial to Company results. The Company is also pursuing other bulk water contracts and acquisitions in and around its service territory to help offset any further declines in per capita water consumption and to grow its business.
On May 10, 2017, the Company signed an emergency interconnect agreement with Dallastown-Yoe Water Authority. The effectiveness of this agreement is contingent upon receiving approval from all required regulatory authorities. Approval is expected to be granted in 2019 at which time the Company will begin construction of a water main extension to a single point of interconnection and either supply a minimum agreed upon amount of water to the authority, receive a payment in lieu of water, or provide water during an emergency, at current tariff rates.
Capital Expenditures
During 2018, the Company invested $16,882 in construction expenditures for routine items and the completion of a raw water pumping station, as well as various replacements and improvements to infrastructure including company-owned lead service lines as discussed in Note 8 to the financial statements included herein. The Company replaced or relined approximately 50,000 feet of main in 2018. The Company was able to fund construction expenditures using internally-generated funds, line of credit borrowings, proceeds from its stock purchase plans, and customer advances and contributions from developers, municipalities, customers or builders. See Notes 1, 4 and 5 to the Company’s financial statements included herein.
The Company anticipates construction and acquisition expenditures for 2019 and 2020 of approximately $21,479 and $21,209, respectively, exclusive of any acquisitions not yet approved. In addition to routine transmission and distribution projects, a portion of the anticipated 2019 and 2020 expenditures will be for additional main extensions, spillway improvements and the armoring of one of the dams, replacing a water storage tank, expansion of a wastewater treatment plant, and various replacements of infrastructure. The Company intends to use primarily internally-generated funds for its anticipated 2019 and 2020 construction and fund the remainder through line of credit borrowings, proceeds from its stock purchase plans and customer advances and contributions (see Note 1 to the Company’s financial statements included herein). Customer advances and contributions are expected to account for between 5% and 10% of funding requirements in 2019 and 2020. Potential debt and equity offerings may be utilized if required. The Company believes it will have adequate credit facilities and access to the capital markets, if necessary, during 2019 and 2020, to fund anticipated construction and acquisition expenditures.
Liquidity and Capital Resources
Cash
The Company manages its cash through a cash management account that is directly connected to a line of credit. Excess cash generated automatically pays down outstanding borrowings under the line of credit arrangement. If there are no outstanding borrowings, the cash is used as an earnings credit to reduce banking fees. Likewise, if additional funds are needed beyond what is generated internally for payroll, to pay suppliers, or for debt service, funds are automatically borrowed under the line of credit. The Company fully utilized its cash on hand in 2017. As of December 31, 2018, the Company borrowed $9,508 under its lines of credit and incurred a cash overdraft on its cash management account of $1,070. The cash management facility and the other lines of credit are expected to provide the necessary liquidity and funding for the Company’s operations, capital expenditures, acquisitions and potential buybacks of stock for the foreseeable future.
Accounts Receivable
The accounts receivable balance tends to follow the change in revenues but is also affected by the timeliness of payments by customers and the level of the reserve for doubtful accounts. In 2018, the accounts receivable – customers balance increased due to an increase in revenue from increased customer counts and the DSIC. Other receivables increased due to the timing of a large receivable to fund a capital project which was received in January 2019. A reserve is maintained at a level considered adequate to provide for losses that can be reasonably anticipated based on inactive accounts with outstanding balances. Management periodically evaluates the adequacy of the reserve based on past experience, agings of the receivables, adverse situations that may affect a customer’s ability to pay, current economic conditions, and other relevant factors. If the status of these factors deteriorates, the Company may incur additional expenses for uncollectible accounts and experience a reduction in its internally-generated funds.
Internally-generated Funds
The amount of internally-generated funds available for operations and construction depends on the Company’s ability to obtain timely and adequate rate relief, changes in regulations, customers’ water usage, weather conditions, customer growth and controlled expenses. In 2018, the Company generated $18,372 internally as compared to $20,110 in 2017. The decrease from 2017 was primarily due to higher income taxes paid.
Credit Lines
Historically, the Company has borrowed $15,000 to $20,000 under its lines of credit before refinancing with long-term debt or equity capital. As of December 31, 2018, the Company maintained unsecured lines of credit aggregating $41,500 with four banks at interest rates ranging from LIBOR plus 1.15% to LIBOR plus 1.25%. The Company had $9,508 in outstanding borrowings under its lines of credit as of December 31, 2018. The weighted average interest rate on line of credit borrowings as of December 31, 2018 was 3.60%. The Company expects to renew these lines of credit as they mature under similar terms and conditions.
The Company has taken steps to manage the risk of reduced credit availability. It has maintained committed lines of credit that cannot be called on demand and obtained a 2-year revolving maturity on most of its facilities. One of the Company’s banks recently reduced the interest rate on its line of credit and extended the maturity from one year to two years. There is no guarantee that the Company will be able to obtain sufficient lines of credit with favorable terms in the future. If the Company is unable to obtain sufficient lines of credit or to refinance its line of credit borrowings with long-term debt or equity when necessary, it may have to eliminate or postpone capital expenditures. Management believes the Company will have adequate capacity under its current lines of credit to meet financing needs throughout 2019.
Long-term Debt
The Company’s loan agreements contain various covenants and restrictions. Management believes it is currently in compliance with all of these restrictions. See Note 6 to the Company’s financial statements included herein for additional information regarding these restrictions.
The Pennsylvania Economic Development Financing Authority Series 2014 bonds contain special redemption provisions. Under these provisions, representatives of deceased beneficial owners have the right to request redemption prior to the stated maturity of all or part of their holding in the bonds. The Company is not obligated to redeem any individual holding exceeding $25, or aggregate holdings exceeding $300 in any annual period. In 2017 and 2018, no bonds were retired under these provisions. Currently, no additional bonds that meet the special provisions have been tendered for redemption.
The York County Industrial Development Authority Series 2006 bonds are subject to optional redemption provisions that allow the Company to redeem all or a portion of the bonds on or after October 1, 2016. The Company may refinance these bonds prior to maturity in 2036 to take advantage of lower interest rates.
On January 31, 2019, the Company entered into a note purchase agreement with certain institutional investors relating to the private placement of $20,000 aggregate principal amount of the Company’s senior notes. The senior notes bear interest at 4.54% per annum payable semiannually and mature on January 31, 2049. The senior notes are unsecured and unsubordinated obligations of the Company. The Company received net proceeds, after deducting issuance costs, of approximately $19,820. The net proceeds were used to refinance the $11,000 aggregate principal amount of the Company’s 10.17% Series A Senior Notes due February 1, 2019 and the 9.60% Series B Senior Notes due February 1, 2019, and to refinance line of credit borrowings incurred by the Company as interim financing for various capital projects of the Company.
The Company’s total long-term debt as a percentage of the total capitalization, defined as total common stockholders’ equity plus total long-term debt, was 43.2% as of December 31, 2018, compared with 43.7% as of December 31, 2017. The Company began using its lines of credit in 2017 due primarily to increased capital expenditures. The Company expects to allow the debt percentage to trend upward until it approaches fifty percent before considering additional equity. A debt to total capitalization ratio between forty-six and fifty percent has historically been acceptable to the PPUC in rate filings. Due to its recent ability to generate more cash internally, the Company has been able to keep its ratio below fifty percent. See Note 6 to the Company’s financial statements included herein for the details of its long-term debt outstanding as of December 31, 2018.
Income Taxes, Deferred Income Taxes and Uncertain Tax Positions
The 2017 Tax Act, among other things, reduces the federal statutory corporate tax rate for tax years beginning in 2018 from 34% to 21%, eliminates certain deductions, and eliminates bonus depreciation on qualified water and wastewater property.
The Company filed for a change in accounting method under the IRS TPR 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. As a result of the ongoing deduction, the net income tax benefits of $1,307 and $1,796 for the years ended December 31, 2018 and 2017, respectively, reduced income tax expense and flowed-through to net income. The 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. The Company expects to continue to expense these asset improvements in the future.
The Company’s effective tax rate will largely be determined by the level of eligible asset improvements expensed for tax purposes that would have been capitalized for tax purposes prior to the implementation of the TPR.
The Company has a substantial deferred income tax asset primarily due to the excess accumulated deferred income taxes on accelerated depreciation from the 2017 Tax Act and the differences between the book and tax balances of the pension and deferred compensation plans. The Company does not believe a valuation allowance is required due to the expected generation of future taxable income during the periods in which those temporary differences become deductible.
The Company has seen an increase in its deferred income tax liability amounts primarily as a result of the accelerated and bonus depreciation deduction available for federal tax purposes which creates differences between book and tax depreciation expense. The Company expects this trend to continue as it makes significant investments in capital expenditures subject to accelerated depreciation or TPR, but at a more modest rate due to the elimination of bonus depreciation on qualified water and wastewater property.
The Company has determined there are no uncertain tax positions that require recognition as of December 31, 2018. See Note 14 to the Company’s financial statements included herein for additional details regarding income taxes.
Common Stock
Common stockholders’ equity as a percent of the total capitalization was 56.8% as of December 31, 2018, compared with 56.3% as of December 31, 2017. The ratio increased slightly in 2018 due to the absence of share repurchases. The volume of share repurchases and higher debt from capital expenditures, among other things, could reduce this percentage in the future. It is the Company’s intent to target a ratio between fifty and fifty-four percent.
Credit Rating
On February 9, 2018, Standard & Poor’s affirmed the Company’s credit rating at A-, with a stable outlook. The Company’s ability to maintain its credit rating depends, among other things, on adequate and timely rate relief, which it has been successful in obtaining, its ability to fund capital expenditures in a balanced manner using both debt and equity and its ability to generate cash flow. In 2019, the Company’s objectives are to continue to maximize its funds provided by operations and maintain a strong capital structure in order to be able to attract capital.
Physical and Cyber Security
The Company maintains security measures at its facilities, and collaborates with federal, state and local authorities and industry trade associations regarding information on possible threats and security measures for water and wastewater utility operations. The costs incurred are expected to be recoverable in water and wastewater rates and are not expected to have a material impact on its business, financial condition, or results of operations.
The Company relies on information technology systems in connection with the operation of the business, especially with respect to customer service, billing, accounting, and in some cases, the monitoring and operation of treatment, storage and pumping facilities. In addition, the Company relies on these systems to track utility assets and to manage maintenance and construction projects, materials and supplies, and human resource functions. The information technology systems may be vulnerable to damage or interruption from cyber security attacks or other cyber-related events, including, but not limited to, power loss, computer systems failures, internet, telecommunications or data network failures, physical and electronic loss of data, computer viruses, intentional security breaches, hacking, denial of service actions, misappropriation of data, and similar events. In some cases, administration of certain functions may be outsourced to third-party service providers that could also be targets of cyber security attacks. A loss of these systems, or major problems with the operation of these systems, could harm the business, financial condition, and results of operations of the Company through the loss or compromise of customer, financial, employee, or operational data, disruption of billing, collections or normal field service activities, disruption of electronic monitoring and control of operational systems, and delays in financial reporting and other normal management functions.
Possible impacts associated with a cyber security attack or other events may include remediation costs related to lost, stolen, or compromised data, repairs to data processing systems, increased cyber security protection costs, adverse effects on our compliance with regulatory and environmental laws and regulation, including standards for drinking water, litigation, and reputational damage.
The Company has implemented processes, procedures and controls to prevent or limit the effect of these possible events, and maintains insurance to help defray costs associated with cyber security attacks. The Company has not experienced a material impact on business or operations from these attacks. Although the Company does not believe its systems are at a materially greater risk of cyber security attacks than other similar organizations and despite the implementation of robust security measures, the Company cannot provide assurance that the insurance will fully cover the costs of a cyber security event, and its robust security measures do not guarantee that reputation and financial results will not be adversely affected by such an incident.
Environmental Matters
The Company entered into a consent order agreement with the Pennsylvania Department of Environmental Protection in December 2016 after the Company determined it exceeded the action level for lead as established by the Lead and Copper Rule, or LCR, issued by the U.S. Environmental Protection Agency. Under the agreement, the Company committed to exceed the LCR replacement schedule by replacing all of the remaining known company-owned lead service lines within four years from the agreement. The cost for these service line replacements was approximately $2,341 through December 31, 2018 and is included in utility plant. As of December 31, 2018, all known company-owned lead service lines have been replaced. Any additional company-owned lead service lines that are discovered will be replaced but are not expected to have a material impact on the financial position of the Company.
Due to its exceedance in 2016, the Company was required under the LCR to complete two rounds of compliance testing at the customer’s tap in 2017. The water samples did not exceed the action level either time. As a result, the Company was able to reduce its monitoring to annual compliance tests beginning in 2018. The Company completed its compliance testing at the customer’s tap in 2018 and the water samples did not exceed the action level. In addition, the Company performed in excess of the required actions under the LCR. Specifically, the Company provided 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 and $16 for the years ended December 31, 2018 and 2017, respectively. Additional amounts for water tests and flushing credits are not expected to have a material impact on the financial position of the Company.
The Company was 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, 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 from the agreement. 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 four-year period. The cost for the customer-owned lead service line replacements under the four-year tariff modification was approximately $304 through December 31, 2018 and is included as a regulatory asset. All known customer-owned lead service lines that are connected to a company-owned lead service line have been replaced by December 31, 2018. Based on its experience, the Company estimates that lead customer-owned service lines replacements will cost $910 under the nine-year tariff modification. This estimate is subject to adjustment as more facts become available.
Dividends
During 2018, the Company's dividend payout ratios relative to net income and net cash provided by operating activities were 65.0% and 46.7%, respectively. During 2017, the Company's dividend payout ratios relative to net income and net cash provided by operating activities were 64.1% and 40.9%, respectively. During the fourth quarter of 2018, the Board of Directors increased the dividend by 4.02% from $0.1666 per share to $0.1733 per share per quarter.
The Company’s Board of Directors declared a dividend in the amount of $0.1733 per share at its January 2019 meeting. The dividend is payable on April 15, 2019 to shareholders of record as of February 28, 2019. While the Company expects to maintain this dividend amount in 2019, future dividends will be dependent upon the Company’s earnings, financial condition, capital demands and other factors and will be determined by the Company’s Board of Directors. See Note 6 to the Company’s financial statements included herein for restrictions on dividend payments.
Inflation
The Company is affected by inflation, most notably by the continually increasing costs incurred to maintain and expand its service capacity. The cumulative effect of inflation results in significantly higher facility replacement costs which must be recovered from future cash flows. The ability of the Company to recover this increased investment in facilities is dependent upon future rate increases, which are subject to approval by the PPUC. The Company can provide no assurances that its rate increases will be approved by the PPUC; and, if approved, the Company cannot guarantee that these rate increases will be granted in a timely or sufficient manner to cover the investments and expenses for which the rate increase was sought.
Critical Accounting Estimates
The methods, estimates, and judgments the Company used in applying its accounting policies have a significant impact on the results reported in its financial statements. The Company’s accounting policies require management to make subjective judgments because of the need to make estimates of matters that are inherently uncertain. The Company’s most critical accounting estimates include: regulatory assets and liabilities, revenue recognition, accounting for its pension plans, and income taxes.
Regulatory Assets and Liabilities
Generally accepted accounting principles define accounting standards for companies whose rates are established by or are subject to approval by an independent third-party regulator. In accordance with the accounting standards, the Company defers costs and credits on its balance sheet as regulatory assets and liabilities when it is probable that these costs and credits will be recognized in the rate-making process in a period different from when the costs and credits were incurred. These deferred amounts are then recognized in the statement of income in the period in which they are reflected in customer rates. If the Company later finds that these assets and liabilities cannot be included in rate-making, they are adjusted appropriately. See Note 1 for additional details regarding regulatory assets and liabilities.
Revenue Recognition
Operating revenues include amounts billed to metered water and certain wastewater customers on a cycle basis and unbilled amounts based on both actual and estimated usage from the latest meter reading to the end of the accounting period. Estimates are based on average daily usage for those particular customers. The unbilled revenue amount is recorded as a current asset on the balance sheet. Actual results could differ from these estimates and would result in operating revenues being adjusted in the period in which the actual usage is known. Based on historical experience, the Company believes its estimate of unbilled revenues is reasonable.
The Company adopted Accounting Standards Update No. 2014-09 beginning January 1, 2018. See Note 1 to the Company’s financial statements included herein for details on the adoption of this standard.
Pension Accounting
Accounting for defined benefit pension plans requires estimates of future compensation increases, mortality, the discount rate, and expected return on plan assets as well as other variables. These variables are reviewed annually with the Company’s pension actuary. The Company used compensation increases of 2.5% to 3.0% in 2017 and 2018.
The Company adopted a new mortality table in 2014, the RP-2014, using the white collar table for the administrative and general plan and the blue collar table for the union plan. Using the new mortality table increased the life expectancy of pension plan participants, resulting in a significant increase to the pension benefit obligation, and ultimately, a decline in the Company’s funded status of the plans. In 2015, the Social Security Administration released new underlying data creating an Adjusted RP-2014 mortality table. A new mortality improvement scale was released in each subsequent year. The Company adopted each of the improvement scales in the years they were released. These changes partially offset the increase in the pension benefit obligation realized in 2014.
The Company selected its December 31, 2018 and 2017 discount rates based on the FTSE Pension Liability Index, formerly the Citi Pension Liability Index. This index uses spot rates for durations out to 30 years and matches them to expected disbursements from the plan over the long term. The Company believes this index most appropriately matches its pension obligations. The present values of the Company’s future pension obligations were determined using a discount rate of 4.10% at December 31, 2018 and 3.5% at December 31, 2017.
Adopting a new mortality table that represents a change in life expectancy and choosing a different discount rate normally changes the amount of pension expense and the corresponding liability. In the case of the Company, these items change its liability, but do not have an impact on its pension expense. The PPUC, in a previous rate settlement, agreed to grant recovery of the Company’s contribution to the pension plans in customer rates. As a result, under the accounting standards regarding rate-regulated activities, expense in excess of the Company’s pension plan contribution can be deferred as a regulatory asset and expensed as contributions are made to the plans and are recovered in customer rates. Therefore, these changes affect regulatory assets rather than pension expense.
The Company’s estimate of the expected return on plan assets is primarily based on the historic returns and projected future returns of the asset classes represented in its plans. The target allocation of pension assets is 50% to 70% equity securities, 30% to 50% fixed income securities, and 0% to 10% cash reserves. The Company used 6.75% as its expected rate of return in 2017 and 2018. A decrease in the expected pension return would normally cause an increase in pension expense; however due to the aforementioned rate settlement, the Company’s expense would continue to be equal to its contributions to the plans. The change would instead be recorded in regulatory assets.
Lower discount rates and underperformance of assets could cause future required contributions and expense to increase substantially. If this were to happen, the Company would have to consider changes to its pension plan benefits and possibly request additional recovery of expenses through increased rates charged to customers. See Note 11 to the Company’s financial statements included herein for additional details regarding the pension plans.
Income Taxes
The Company estimates the amount of income tax payable or refundable for the current year and the deferred income tax liabilities and assets that results from estimating temporary differences resulting from the treatment of certain items, such as depreciation, for tax and financial statement reporting. Generally, these differences result in the recognition of a deferred tax asset or liability on the balance sheet and require the Company to make judgments regarding the probability of the ultimate tax impact of the various transactions entered into. Based on these judgments, it may require tax reserves or valuation allowances on deferred tax assets to reflect the expected realization of future tax benefits. The Company believes its determination of what qualifies as a repair expense tax deduction versus a capital cost as it relates to the IRS TPR ongoing and catch-up deductions is consistent with the regulations. The Company also believes it has appropriately applied the provisions of the 2017 Tax Act including properly applying the accounting standards related to the 2017 Tax Act. Actual income taxes could vary from these estimates and changes in these estimates could increase income tax expense in the period that these changes in estimates occur.
Other critical accounting estimates are discussed in the Significant Accounting Policies Note to the Financial Statements
Off-Balance Sheet Transactions
The Company does not use off-balance sheet transactions, arrangements or obligations that may have a material current or future effect on financial condition, results of operations, liquidity, capital expenditures, capital resources or significant components of revenues or expenses. The Company does not use securitization of receivables or unconsolidated entities. For risk management purposes, the Company uses a derivative financial instrument, an interest rate swap agreement discussed in Note 7 to the financial statements included herein. The Company does not engage in trading or other risk management activities, does not use other derivative financial instruments for any purpose, has no material lease obligations, no guarantees and does not have material transactions involving related parties.
Impact of Recent Accounting Pronouncements
See Note 1 to the Company’s financial statements included herein for a discussion on the effect of new accounting pronouncements.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk. |
Not applicable.
| Item 8. | Financial Statements. |
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of
The York Water Company
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying balance sheets of The York Water Company (the "Company") as of December 31, 2018 and 2017, the related statements of income, common stockholders' equity, and cash flows for the years then ended, and the related notes and financial statement schedule listed in Item 15(a)2 (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/Baker Tilly Virchow Krause, LLP
We have served as the Company’s auditor since 2003.
York, Pennsylvania
March 12, 2019
