(Dollar amounts in thousands, except per share amounts and otherwise noted)
The information in this Item 2 should be read in conjunction with the financial
information and the notes thereto included in Item 1 of this Form 10-Q and the
consolidated financial statements and notes thereto and the related
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" contained in
General:
SJW Group is a holding company with four wholly-owned subsidiaries:San Jose Water Company ("SJWC"),SJWNE LLC as ofOctober 9, 2019 ,SJWTX, Inc. andSJW Land Company . SJWC is a public utility in the business of providing water service to approximately 232,000 connections that serve a population of approximately one million people in an area comprising approximately 139 square miles in the metropolitanSan Jose, California area. The principal business of SJWC consists of the production, purchase, storage, purification, distribution, wholesale, and retail sale of water. SJWC provides water service to customers in portions of the cities ofSan Jose andCupertino and in the cities ofCampbell ,Monte Sereno ,Saratoga and theTown of Los Gatos , and adjacent unincorporated territories, all in the County ofSanta Clara in theState of California . SJWC distributes water to customers in accordance with accepted water utility methods which include pumping from storage and gravity feed from high elevation reservoirs. SJWC also provides non-tariffed services under agreements with municipalities and other utilities. These non-tariffed services include water system operations, maintenance agreements, and antenna site leases. SJWC has utility property including land held in fee, impounding reservoirs, diversion facilities, wells, distribution storage, and all water facilities, equipment, office buildings and other property necessary to supply its customers. Under Section 851 of the California Public Utilities Code, properties currently used and useful in providing utilities services cannot be disposed of unlessCalifornia Public Utilities Commission ("CPUC") approval is obtained. SJWC also has approximately 411 acres of nonutility property which has been identified as no longer used and useful in providing utility services. The majority of the properties are located in the hillside areas adjacent to SJWC's various watershed properties.SJWTX, Inc. , doing business asCanyon Lake Water Service Company ("CLWSC"), is a public utility in the business of providing water service to approximately 18,000 connections that serve approximately 54,000 people. CLWSC's service area comprises more than 246 square miles in the southern region of the Texas Hill Country inBlanco ,Comal ,Hays andTravis counties, the growing region betweenSan Antonio andAustin, Texas .SJWTX, Inc. has a 25% interest inAcequia Water Supply Corporation ("Acequia"). The water supply corporation has been determined to be a variable interest entity within the scope of ASC Topic 810 withSJWTX, Inc. as the primary beneficiary. As a result, Acequia has been consolidated withSJWTX, Inc. SJW Land Company owns undeveloped land and operates commercial buildings inTennessee .SJW Land Company also owns a 70% limited partnership interest in444 West Santa Clara Street , L.P. which operated aCalifornia commercial property that was sold in the second quarter of 2017. The limited partnership has been determined to be a variable interest entity within the scope ofFinancial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 810 - "Consolidation" withSJW Land Company as the primary beneficiary, and as a result, has been consolidated withSJW Land Company .Connecticut Water Service, Inc. ("CTWS"), headquartered inConnecticut , is a holding company for water utilities companies providing water service to approximately 138,000 connections that serve a population of approximately 480,000 people in 80 municipalities throughoutConnecticut andMaine and more than 3,000 wastewater connections inSouthbury, Connecticut . As part of the merger transaction betweenSJW Group and CTWS onOctober 9, 2019 , CTWS became a wholly-owned subsidiary ofSJWNE LLC which is a wholly-owned subsidiary ofSJW Group . The subsidiaries held by CTWS that provide utility water 21
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services are TheConnecticut Water Company ("Connecticut Water"),The Heritage Village Water Company ("HVWC"),The Avon Water Company ("Avon Water") andThe Maine Water Company ("Maine Water"). The remaining two subsidiaries areChester Realty, Inc. , a real estate company inConnecticut , andNew England Water Utility Services, Inc. ("NEWUS"), which provides contract water and sewer operations and other water related services. CTWS also offers Linebacker, an optional service line protection program offered by CTWS to eligible residential customers through NEWUS inConnecticut andMaine Water inMaine covering the cost of repairs for leaking or broken water service lines which provide drinking water to a customer's home. For customers who enroll in this program, CTWS will repair or replace a leaking or broken water service line and related equipment. Additionally, NEWUS offers expanded coverage to Connecticut Water customers for failure of in-home plumbing, sewer and septic drainage lines and implemented modified terms and conditions with limitations on certain coverages. The properties of CTWS consist of land, easements, rights (including water rights), buildings, reservoirs, standpipes, dams, wells, supply lines, water treatment plants, pumping plants, transmission and distribution mains and other facilities and equipment used for the collection, purification, storage and distribution of water throughoutConnecticut andMaine . In certain cases, Connecticut Water and Maine Water are or may be a party to limited contractual arrangements for the provision of water supply from neighboring utilities.SJW Land Company owned the following real properties during the three months endedMarch 31, 2020 : % for Three months ended March 31, 2020 of SJW Land Company Description Location Acreage Square Footage Revenue Expense Warehouse building Knoxville, Tennessee 30 361,500 48 % 40 % Commercial building Knoxville, Tennessee 15 135,000 52 % 60 % Undeveloped land and Knoxville, parking lot Tennessee 10 N/A N/A N/A Undeveloped land San Jose, California 103 N/A N/A N/A
As of
Business Strategy for Water Utility Services:
(2) Regional non-tariffed water utility related services provided in accordance with the guidelines established by the CPUC inCalifornia , thePublic Utilities Regulatory Authority inConnecticut ("PURA"), thePublic Utilities Commission of Texas ("PUCT") inTexas , and theMaine Public Utilities Commission ("MPUC") inMaine ; and
(3) Out-of-region water and utility related services.
As part of our pursuit of the above three strategic areas, we consider from time
to time opportunities to acquire businesses and assets, including the recent
CTWS merger which closed on
22
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interest in
Critical Accounting Policies:
The discussion and analysis of our financial condition and results of operations
is based on the accounting policies used and disclosed in our 2019 consolidated
financial statements and accompanying notes that were prepared in accordance
with accounting principles generally accepted in
New Accounting Pronouncements:
In
Results of Operations: Water sales are seasonal in nature and influenced by weather conditions. The timing of precipitation and climatic conditions can cause seasonal water consumption by customers to vary significantly. Due to the seasonal nature of the water business, the operating results for interim periods are not indicative of the operating results for a 12-month period. Revenue is generally higher in the warm, dry summer months when water usage and sales are greater, and lower in the winter months when cooler temperatures and increased rainfall curtail water usage and sales. OverviewSJW Group's consolidated net income for the three months endedMarch 31, 2020 , was$2,417 , a decrease of$3,456 , or approximately 59%, from$5,873 for the same period in 2019. The decrease in net income for the three months endedMarch 31, 2020 , was primarily due to an increase in production expenses at SJWC due to a decrease in the use of available surface water and an increase in customer usage, and an increase in interest on long-term debt used to acquireSJWNE LLC and issuance of SJWC's Series M note. These increases were partially offset by the addition of net income from the company's newSJWNE LLC utility operations, and customer usage and rate increases at SJWC.an increase in operating revenue. Operating Revenue Operating Revenue by Segment Three months ended March 31, 2020 2019 Water Utility Services $ 114,384 76,316 Real Estate Services 1,370 1,366 $ 115,754 77,682 23
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The change in consolidated operating revenues was due to the following factors:
Three months ended March 31, 2020 vs. 2019 Increase/(decrease) Water Utility Services: Consumption changes$ 6,029 7 % Increase in customers 425 1 % Rate increases 3,508 5 % Balancing and memorandum accounts: Water Conservation Memorandum Account ("WCMA") 1,140 2 % All others (438 ) (1 )% SJWNE LLC 27,404 35 % Real Estate Services 4 - %$ 38,072 49 % Operating Expense Operating Expense by Segment Three months ended March 31, 2020 2019 Water Utility Services $ 97,378 61,426 Real Estate Services 831 891 All Other 2,118 2,957 $ 100,327 65,274
The change in consolidated operating expenses was due to the following factors:
Three months ended March 31, 2020 vs. 2019 Increase/(decrease) Water production expenses: Change in surface water use$ 5,437 8 % Change in usage and new customers 5,292 8 %
Purchased water and groundwater extraction charge and energy price increase
1,523 2 % Balancing and memorandum accounts cost recovery (1,512 ) (2 )% SJWNE LLC 6,256 10 % Total water production expenses 16,996 26 % Administrative and general 9,202 14 % Balance and memorandum account cost recovery (231 ) - % Maintenance 1,761 2 % Property taxes and other non-income taxes 3,335 5 % Depreciation and amortization 6,237 10 % Merger related expenses (2,247 ) (3 )%$ 35,053 54 %
Sources of Water Supply
SJWC's water supply consists of groundwater from wells, surface water from
watershed run-off and diversion, reclaimed water, and imported water purchased
from the
24
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billion gallons. The dependable yield from our 235 active wells and 18 surface
water supplies is approximately 65 million gallons per day. Water sources vary
among the individual systems, but overall approximately 80% of the total
dependable yield comes from surface water supplies and 20% from wells.
CLWSC's water supply consists of groundwater from wells and purchased treated
and untreated raw water from local water agencies. CLWSC has long-term
agreements with the
Three months ended March 31, Increase/ % of Total 2020 2019 (decrease) Change Purchased water 3,635 3,162 473 7 % Groundwater 4,345 1,832 2,513 38 % Surface water 2,051 1,577 474 7 % Reclaimed water 86 45 41 1 % 10,117 6,616 3,501 53 % The changes in the source of supply mix were consistent with the changes in the water production expenses. SJWC's unaccounted-for water on a 12-month-to-date basis forMarch 31, 2020 , and 2019 approximated 8.0% and 6.6%, respectively, as a percentage of total production. The unaccounted-for water estimate is based on the results of past experience and the impact of flows through the system, partially offset by SJWC's main replacements and lost water reduction programs. CTWS's unaccounted-for water on an acquisition-to-date basis for the period endingMarch 31, 2020 was approximately 16.1% as a percentage of total production. The unaccounted-for water estimate is based on the results of past experience and the impact of flows through CTWS's systems, unadjusted for any required system flushing, partially offset by WICA and WISC main replacement programs and lost water reduction initiatives. Water Production Expenses The change in water production expenses for the three months endedMarch 31, 2020 , compared to the same period in 2019, was primarily attributable to the newSJWNE LLC operations, a decrease in the use of surface water, an increase in customer usage and higher per unit costs for purchased water, groundwater extraction and energy charges, offset by a decrease in cost-recovery balancing and memorandum accounts. EffectiveJuly 1, 2019 , Valley Water increased the unit price of purchased water by approximately 6.1% and the groundwater extraction charge by approximately 6.6%. Other Operating Expenses Operating expenses, excluding water production expenses, increased$18,057 for the three months endedMarch 31, 2020 , compared to the same period in 2019. The increase was primarily attributable to an increase of$15,951 due to the newSJWNE LLC operations, and increases of$1,533 in administrative and general expenses primarily due to legal and accounting fees,$1,106 in depreciation and amortization expense due to increases in utility plant, and an increase of COVID-19 related reserves and expenses of$555 , partially offset by a decrease in merger related expenses due to the completion of the merger with CTWS. Other (Expense) Income For the three months endedMarch 31, 2020 , compared to the same periods in 2019, the change in other (expense) income was primarily due to an increase in interest on long-term debt as a result of the issuance ofSJW Group's Series 2019A, B and C 25
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notes and SJWC's Series M note. In addition, interest income decreased due to use of previously invested money market funds for the merger with CTWS. Provision for Income Taxes For the three months endedMarch 31, 2020 , compared to the same period in 2019, income tax expense decreased$1,607 . The decrease in income tax expense of$1,607 is primarily due to a lower pre-tax income in the three months endedMarch 31, 2020 and the flow-through tax benefits of certain CTWS tax attributes. The effective consolidated income tax rates were 15% and 26% for the three months endedMarch 31, 2020 and 2019, respectively. OnMarch 27, 2020 , the Coronavirus Aid, Relief, and Economic Security ("CARES") Act was signed into law. The CARES Act includes, among other items, measures concerning income taxes. Many of the CARES Act's requirements are subject to further clarification. The Company has considered the income tax provisions of the CARES Act in the first quarter of 2020.SJW Group expects the Internal Revenue Service to issue guidance in future periods that will determine the final disposition of the excess deferred taxes and other impacts of the Tax Cuts and Jobs Act (H.R. 1). At this time, the company has applied a reasonable interpretation of the Tax Act. Future clarification of the Tax Act may change estimated amounts. California Water Supply OnApril 1, 2020 , Valley Water's 10 reservoirs were approximately 35% of total capacity with 58,563 acre-feet of water in storage, which is 56% of the twenty-year average for this date. As reported by the Valley Water, there was 7.24 inches of rainfall inSan Jose during the current annual rainfall season that commenced onJuly 1, 2019 , that included one of the driest February's on record. Rainfall at SJWC'sLake Elsman was measured at 23.78 inches during the current rainfall season. Under normal hydrologic conditions, state and federal water allocations represent approximately 40% of the Valley Water's total annual water supply. As ofApril 1, 2020 , the Valley Water reported that allocations from the state and federal water project are approximately 15% and 65%, respectively, of amounts requested in 2020. Valley Water also reported that the managed groundwater recharge from January to March in theSanta Clara Plain was 121% of the five-year average. The groundwater level in theSanta Clara Plain is approximately four feet lower than a year ago in February and nine feet higher than the five-year average. The groundwater level in theSanta Clara Plain was not measured in March due to the COVID-19 shelter in place order. According to Valley Water, the projected total groundwater storage at the end of 2020 is expected to fall within the normal stage of the Valley Water's Water Shortage Contingency Plan. OnApril 1, 2020 , SJWC'sLake Elsman contained 1,384 acre-feet of water, of which approximately 924 acre-feet can be utilized for treatment. ThisLake Elsman volume represents 50% of the five-year average. Local surface water is a less costly source of water than groundwater or purchased water and its availability significantly impacts SJWC's results of operations. SJWC will utilize surface water and additional water from its portfolio of groundwater supplies to supplement imported water from the Valley Water. Production from theMontevina Surface Water Treatment Plant through the first quarter was 334 million gallons, which is 46% of the five-year average. Production at SJWC's smallerSaratoga Water Treatment Plant through the first quarter was 48 million gallons, which is 48% of the five-year average. SJWC believes that its various water supply sources will be sufficient to meet customer demand through the remainder of 2020. Regulation and Rates Almost all of the operating revenue ofSJW Group results from the sale of water at rates authorized by the subsidiaries' respective state utilities commissions. The state utilities commissions set rates that are intended to provide revenue sufficient to recover operating expenses and the opportunity to achieve a specified return on common equity. The timing of rate decisions could have an impact on the results of operations. See Note 8 of Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of regulatory activities that have occurred during the quarter.
Liquidity:
Cash Flow from Operating Activities
During the three months ended
26
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in interest accruals for new debt and debt acquired by the merger with CTWS., and (5) general working capital and net income, adjusted for non-cash items increased by$4,900 . As ofMarch 31, 2020 , Water Utility Services' write-offs for uncollectible accounts represent less than 1% of its total revenue, unchanged fromMarch 31, 2019 . InMarch 2020 , the regulated utilities commissions of the respective states we operate in have made executive orders suspending water service disconnections due to non-payment from customers in light of the current stay-at-home orders, quarantines and similar governmental restrictions for the global COVID-19 pandemic. Management believes that the historical collection rate for its accounts receivable will decrease during the COVID-19 pandemic and although any financial impact is currently tracked to be filed through the rate-making process, there is no guarantee that such recovery will be approved by the respective regulatory utility commissions. Cash Flow from Investing Activities During the three months endedMarch 31, 2020 ,SJW Group used cash flows in investing activities of approximately$42,500 , compared to$34,400 for the same period in 2019.SJW Group used approximately: (1)$38,300 of cash for company-funded capital expenditures, (2)$3,600 for developer-funded capital expenditures, and (3)$300 in utility plant retirement costs. Water Utility Services' budgeted capital expenditures for 2020, exclusive of capital expenditures financed by customer contributions and advances, are approximately$225,800 . As ofMarch 31, 2020 , approximately$38,300 or 17% of the$225,800 has been spent. Water Utility Services' capital expenditures are incurred in connection with normal upgrading and expansion of existing facilities and to comply with environmental regulations. Over the next five years, Water Utility Services expect to incur approximately$1.2 billion in capital expenditures, which includes replacement of pipes and mains, and maintaining water systems. A significant portion of this amount is subject to future CPUC, PURA, PUCT or MPUC approval. Capital expenditures have the effect of increasing utility plant rate base on which Water Utility Services earns a return. Water Utility Services actual capital expenditures may vary from their projections due to changes in the expected demand for services, weather patterns, actions by governmental agencies, and general economic conditions. Total additions to utility plant normally exceed Company-financed additions as a result of new facilities construction funded with advances from developers and contributions in aid of construction. The Water Utility Services' distribution systems were constructed during the period from the early 1900's through today. Expenditure levels for renewal and modernization will occur as the components reach the end of their useful lives. In most cases, replacement cost will significantly exceed the original installation cost of the retired assets due to increases in the costs of goods and services and increased regulation. Cash Flow from Financing Activities Net cash provided by financing activities for the three months endedMarch 31, 2020 , increased by approximately$36,700 from the same period in the prior year, primarily as a result of (1) an increase in net borrowings on our lines of credit of$82,200 , and (2)$1,500 increase in net cash receipts from advances and contributions in aid of construction, offset by (3) a decrease in net proceeds from new long-term debt of$45,000 . Sources of Capital:SJW Group's ability to finance future construction programs and sustain dividend payments depends on its ability to maintain or increase internally generated funds and attract external financing. The level of future earnings and the related cash flow from operations is dependent, in large part, upon the timing and outcome of regulatory proceedings.SJW Group's unsecured senior note agreements has terms and conditions that restrictSJW Group from issuing additional funded debt if: (1) the funded consolidated debt would exceed 66-2/3% of total capitalization, and (2) the minimum net worth ofSJW Group becomes less than$175,000 plus 30% of Water Utility Services cumulative net income, sinceJune 30, 2011 .SJW Group was not restricted from issuing future indebtedness as a result of these terms and conditions atMarch 31, 2020 . SJWC's financing activity is designed to achieve a capital structure consistent with our CPUC authorized structure of approximately 47% debt and 53% equity. As ofMarch 31, 2020 , SJWC's funded debt and equity were approximately 49% and 51%, respectively. Funding for SJWC's future capital expenditure program is expected to be provided primarily through internally-generated funds, the issuance of new long-term debt, the issuance of equity, all of which will be consistent with regulator guidelines. SJWC's unsecured senior note agreements generally have terms and conditions that restrict SJWC from issuing additional funded debt if: (1) the funded debt would exceed 66-2/3% of total capitalization, and (2) net income available for interest charges for the trailing 12-month-calendar period would be less than 175% of interest charges. SJWC was not restricted from issuing future indebtedness as a result of these terms and conditions atMarch 31, 2020 . 27
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SJWC's loan agreements with theCalifornia Pollution Control Financing Authority contain affirmative and negative covenants customary for loan agreements relating to revenue bonds, including, among other things, complying with certain disclosure obligations and covenants relating to the tax exempt status of the interest on the bonds and limitations and prohibitions relating to the transfer of the projects funded by the loan proceeds and the assignment of the loan agreement. As ofMarch 31, 2020 , SJWC was in compliance with all such covenants. CTWS has outstanding term loans with a commercial bank and under the master loan agreement, CTWS is required to comply with certain financial ratio and operational covenants. The most restrictive of these covenants is to maintain a consolidated (CTWS and its subsidiaries) debt to capitalization ratio of not more than 60%. As ofMarch 31, 2020 , CTWS was in compliance with all covenants under the master loan agreement. Connecticut Water has outstanding term loans with a commercial bank and under its master loan agreement, Connecticut Water is required to comply with financial and operational covenants substantially identical to those found in CTWS's master loan agreement. Connecticut Water is required to maintain a debt to capitalization ratio of not more than 60%. As ofMarch 31, 2020 ,Connecticut Water was in compliance with all covenants under its master loan agreement. Connecticut Water has tax exempt and taxable Water Facilities Revenue Bonds issued through Connecticut Innovations (formerly theConnecticut Development Authority ). The bond indentures and loan agreements contain customary affirmative and negative covenants and require compliance with financial and operational covenants, and also provide for the acceleration of the Revenue Bonds upon the occurrence of stated events of default. As ofMarch 31, 2020 , Connecticut Water was in compliance with all covenants of the bond indentures and loan agreements. OnMarch 12, 2020 Connecticut Water entered into a note purchase agreement with the purchasers listed in the agreement, pursuant to which Connecticut Water sold an aggregate principal amount of$35,000 of its 3.51% Senior Notes, dueMarch 12, 2050 . The notes are unsecured obligations of Connecticut Water. Interest is payable semi-annually in arrears onMarch 12th andSeptember 12th of each year. The note purchase agreement contains customary representations and warranties. Under the note purchase agreement, Connecticut Water is required to comply with certain customary affirmative and negative covenants for as long as the notes are outstanding. The notes are also subject to customary events of default, the occurrence of which may result in all of the notes then outstanding becoming immediately due and payable. The closing occurred simultaneously with the signing of the note purchase agreement. Connecticut Water's unsecured senior notes have terms and conditions that restrict Connecticut Water from issuing additional debt or paying a dividend to CTWS if such debt or distribution would trigger an event of default. The senior note agreements also requires Connecticut Water to maintain a debt to capitalization ratio of not more than 60% and an interest coverage ratio at each fiscal quarter end of no less than three-to-one. As ofMarch 31, 2020 , Connecticut Water was in compliance with all financial ratio and operational covenants under this agreement.SJWTX, Inc.'s unsecured senior note agreement has terms and conditions that restrictSJWTX, Inc. from issuing additional funded debt if: (1) the funded debt would exceed 66-2/3% of total capitalization, and (2) net income available for interest charges for the trailing 12-month-calendar period would be less than 175% of interest charges. In addition,SJW Group is a guarantor ofSJWTX, Inc.'s senior note which has terms and conditions that restrictSJW Group from issuing additional funded debt if: (1) the funded consolidated debt would exceed 66-2/3% of total capitalization, and (2) the minimum net worth ofSJW Group becomes less than$125,000 plus 30% of Water Utility Services cumulative net income, sinceDecember 31, 2005 . As ofMarch 31, 2020 ,SJWTX, Inc. andSJW Group were not restricted from issuing future indebtedness as a result of these terms and conditions. Maine Water has First Mortgage Bonds issued to theMaine Municipal Bond Bank through theState Safe Drinking Water Revolving Loan Fund and First Mortgage Bonds issued to One America. The associated bond indentures and loan agreements contain customary affirmative and negative covenants, including a prohibition on the issuance of indebtedness secured by assets or revenue of Maine Water where the lien is senior to the lien of the bond trustee under the above bonds except as permitted by the bond indentures and related loan and security agreements, a requirement to maintain a debt to capitalization ratio of not more than 65%, required compliance with various financial and operational covenants, and a provision for maturity acceleration upon the occurrence of stated events of default. As ofMarch 31, 2020 , Maine Water was in compliance with all covenants in its bond indentures and related loan agreements. Maine Water has outstanding term loans with a commercial bank and under its master loan agreement. Maine Water is required to comply with financial and operational covenants substantially identical to those found in CTWS and Connecticut Water's master loan agreements.Maine is required to maintain a debt to capitalization ratio of not more than 60%. As ofMarch 31, 2020 , Maine Water was in compliance with all covenants under its master loan agreement. HVWC has a term loan with a commercial bank, due in 2034. The loan is secured by real property owned by HVWC. The loan agreement restricts HVWC's ability to incur additional debt and requires compliance with a funded debt to capitalization covenant and other operational covenants. As ofMarch 31, 2020 , HVWC was in compliance with all covenants of the loan. 28
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Avon Water has a mortgage loan that is due in 2033. The loan agreement (1)
generally restricts the ability of Avon Water to incur additional debt or make
dividend payments other than in the ordinary course of business, and (2)
requires submission of periodic financial reports as part of loan covenants. As
of
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