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CTWS > SEC Filings for CTWS > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for CONNECTICUT WATER SERVICE INC / CT | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for CONNECTICUT WATER SERVICE INC / CT


8-Nov-2012

Quarterly Report

Part I, Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following discussion should be read in conjunction with the accompanying unaudited financial statements and related notes thereto and the audited financial statements and the notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2011.

Regulatory Matters and Inflation

Public Utility Regulatory Authority Matters

On July 28, 2011, The Connecticut Water Company ("Connecticut Water") filed a Water Infrastructure Conservation Act ("WICA") application with the Connecticut Public Utilities Regulatory Authority ("PURA") requesting an additional 1.42% surcharge to customer bills representing approximately $7.7 million in WICA related projects. On September 21, 2011, the PURA approved a 1.40% increase to customers' bills effective October 1, 2011, for a cumulative 3.09% WICA surcharge. The surcharge was effective for bills rendered on or after October 1, 2011.

On January 26, 2012, Connecticut Water filed a WICA application with the PURA requesting an additional 1.17% surcharge to customer bills, related to approximately $7.0 million spending on WICA projects. This application also reduced the surcharge by 0.11% for the prior year reconciliation adjustment which expired April 1, 2012. On January 30, 2012, Connecticut Water filed for a 0.09% reconciliation adjustment for the 2011 shortfall in WICA, to become effective April 1, 2012. In March 2012, the PURA approved an increase of 1.16% on the Company's first WICA application and approved the 0.09% reconciliation surcharge from the second application, effective April 1, 2012. As of April 1, 2012, Company's cumulative WICA surcharge was now 4.23%.

On July 26, 2012, Connecticut Water filed a WICA application with the PURA requesting an additional 1.50% surcharge to customer bills, related to approximately $7.7 million spending on WICA projects. In September 2012, the PURA approved the 1.50% increase, effective October 1, 2012. The Company's cumulative WICA surcharge is now 5.73%.

Acquisitions

Effective January 1, 2012, the Company completed the acquisition of Aqua Maine, Inc. ("AM") from Aqua America, Inc. ("AA") for a total cash purchase price, adjusted at closing, of $35.6 million. Subsequent to the closing, the name of AM was changed to The Maine Water Company ("Maine Water"). Maine Water is a public water utility regulated by the Maine Public Utilities Commission ("MPUC") that serves approximately 16,000 customers in 11 water systems in the State of Maine. The acquisition is consistent with the Company's growth strategy and makes the Company the largest U.S. based publicly-traded water utility company in New England. The acquisition expanded the Company's footprint into another New England state, providing some diversity with respect to weather and regulatory climate and ratemaking. The Company is accounting for the acquisition in accordance with Financial Accounting Standards Board ("FASB) Accounting Standards Codification ("ASC") 805 Business Combinations ("FASB ASC 805").

Additionally, in February 2012, Connecticut Water acquired a small water system in Hebron, Connecticut for $130,000. The water system serves three multi-unit apartment buildings.

On July 18, 2012, the Company announced that it had reached an agreement to acquire the Biddeford and Saco Water Company ("Biddeford and Saco"), pending a vote of Biddeford and Saco shareholders, approval by the Maine Public Utilities


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Commission ("MPUC") and the satisfaction of other various conditions. This acquisition will add approximately 15,500 additional customers in the State of Maine, in the communities of Biddeford, Saco, Old Orchard Beach and Scarborough. Under the terms of the agreement, the acquisition will be executed through a stock-for-stock merger transaction valued at approximately $11.4 million. Holders of Biddeford and Saco common stock will receive shares of the Company's common stock in a tax-free exchange. On November 7, 2012, the MPUC approved the transaction. The Company expects the transaction to close in the fourth quarter of 2012.

Critical Accounting Policies and Estimates

The Company maintains its accounting records in accordance with accounting principles generally accepted in the United States of America and as directed by the PURA and the MPUC to which Connecticut Water and Maine Water, respectively, the Company's regulated water utility subsidiaries, are subject. Significant accounting policies employed by the Company, including the use of estimates, were presented in the Notes to Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

Critical accounting policies are those that are the most important to the presentation of the Company's financial condition and results of operations. The application of such accounting policies requires management's most difficult, subjective, and complex judgments and involves uncertainties and assumptions. The Company's most critical accounting policies pertain to public utility regulation related to ASC 980 "Regulated Operations", revenue recognition, and accounting for pension and other post-retirement benefit plans. Each of these accounting policies and the application of critical accounting policies and estimates were discussed in the Company's Annual Report on Form 10-K for the year ended December 31, 2011. Other than the application of ASC 805 "Business Combinations" to the Company's acquisition of Maine Water, there were no significant changes in the application of critical accounting policies or estimates during the three months ended September 30, 2012.

Management must use informed judgments and best estimates to properly apply these critical accounting policies. Because of the uncertainty in these estimates, actual results could differ from estimates used in applying the critical accounting policies. The Company is not aware of any reasonably likely events or circumstances which would result in different amounts being reported that would materially affect its financial condition or results of operations.

Outlook

The following modifies and updates the "Outlook" section of the Company's 2011 Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

The Company's earnings and profitability are primarily dependent upon the sale and distribution of water, the amount of which is dependent on seasonal weather fluctuations, particularly during the summer months when water demand will vary with rainfall and temperature levels. The Company's earnings and profitability in future years will also depend upon a number of other factors, such as the ability to maintain our operating costs at current or lower levels, customer growth in the Company's core regulated water utility businesses, growth in revenues attributable to non-water sales operations, availability and desirability of land no longer needed for water delivery for land sales, and the timing and adequacy of rate relief when requested, from time to time, by our regulated water companies.

The Company expects Net Income from its Water Activities and Real Estate segments to increase in 2012 over 2011 levels, based on the acquisition of Maine Water and the completion of the land sale with the Town of Plymouth, Connecticut, which closed in the second quarter of 2012, along with modest growth in its Services and Rentals segment.

The Company believes that the factors described above and those described in detail below under the heading "Commitments and Contingencies" may have significant impact, either alone or in the aggregate, on the Company's earnings and profitability in fiscal years 2012 and beyond. Please also review carefully the risks and uncertainties described in the sections entitled Item 1A - Risk Factors, "Commitments and Contingencies" in Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011 and the risks and uncertainties described in the "Forward-Looking Information" section below.

Liquidity and Capital Resources

The Company is not aware of demands, events, or uncertainties that will result in a decrease of liquidity or a material change in the mix or relative cost of its capital resources, other than those outlined below.


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Borrowing Facilities

On June 30, 2009, the Company entered into a $15 million line of credit agreement with CoBank, ACB ("CoBank"), which was amended in May 2010, July 2011 and September 2012 and is currently scheduled to mature on July 1, 2014. On October 12, 2012, the Company increased an additional line of credit from $15 million to $20 million, and extended its expiration date to June 30, 2014. Due to the acquisition of Maine Water, the total lines of credit available to the Company increased to $39 million, due to Maine Water's $4 million line of credit expiring December 14, 2012. Maine Water expects to renew the line of credit prior to expiration with similar terms. Interim Bank Loans Payable at September 30, 2012 and December 31, 2011 was approximately $22.6 million and $21.4 million, respectively, and represents the outstanding aggregate balance on these lines of credit. As of September 30, 2012, the Company had $16.4 million in unused lines of credit. Interest expense charged on interim bank loans will fluctuate based on market interest rates.

On January 1, 2012, the Company and CoBank entered into an amendment to the CoBank Agreement (the "Amendment") and two additional Promissory Note and Single Advance Term Loan Supplements providing for two additional Term Loans to the Company (the "Term Loan Notes and Supplements"). Under the terms of the Amendment and the Term Loan Notes and Supplements, on January 3, 2012 the Company borrowed from CoBank, in the aggregate, an additional $36.1 million of an available $40 million to be applied to the Company's acquisition of the issued and outstanding capital stock of Aqua Maine, Inc. from Aqua America, Inc., as more fully described in Note 10 below.

Under one Term Loan Note and Supplement, CoBank loaned the Company $18.0 million, which Term Loan shall be repaid by the Company in 60 equal quarterly installments of principal and interest over a 15-year amortizing term, with the first installment paid on April 20, 2012 and the last installment due on January 20, 2027. Under the other Term Loan Note and Supplement, as amended in September 2012, CoBank loaned the Company $18.1 million, which Term Loan shall be repaid by the Company in quarterly interest payments and repayment of the principal balance in full on the earlier of January 2, 2014 or upon the Company raising equity capital, in the aggregate, up to the outstanding amount owed under the second Term Note and Supplement.

Under the initial Promissory Note and each of the Term Loan Notes and Supplements, the Company will pay interest on any Loans made by CoBank in accordance with one or more of the following interest rate options, as selected periodically by the Company: (1) at a weekly quoted variable rate, a rate per annum equal to the rate of interest established by CoBank on the first business day of each week; (2) at a fixed rate per annum to be quoted by CoBank in its sole discretion in each instance for periods of 180 days or more; or (3) at a fixed rate per annum equal to LIBOR plus 1.75% for 1, 2, 3, 6, 9 or 12 month interest periods. Interest shall be calculated on the actual number of days each Loan is outstanding on the basis of a year consisting of 360 days.

On August 3, 2012, Connecticut Water filed with PURA an application to refinance approximately $55 million of Connecticut Water's long-term debt. The application seeks approval for Connecticut Water to issue four promissory notes in order to redeem five series of Connecticut Water's currently outstanding bonds. The Notes to be issued by Connecticut Water will have terms ranging from 8 to 20 years, will be unsecured and will have fixed interest rates, which would be lower than the rates on the currently outstanding bonds. On September 12, 2012, PURA issued a final decision allowing Connecticut Water to refinance the long-term debt.

On October 29, 2012, Connecticut Water entered into a Master Loan Agreement (the "Agreement") with CoBank, ACB, ("CoBank"). Connecticut Water also delivered to CoBank four Promissory Note and Single Advance Term Loan Supplements, each dated October 29, 2012 (the "Promissory Notes"). On the terms and subject to the conditions set forth in the Promissory Notes issued pursuant to the Agreement, CoBank agreed to make unsecured loans (each a "Loan," and collectively the "Loans") to Connecticut Water from time to time, in an aggregate principal amount of up to $54,645,000. Connecticut Water used substantially all of the proceeds of the Loans to refinance the 1998 Series A, 1998 Series B, 2003A Series, 2003C Series and 2005A Series bonds outstanding.

The Agreement contains customary representations and warranties, which are in certain cases modified by "materiality" and "knowledge" qualifiers, and customary affirmative and negative covenants. Subject to the payment of a surcharge described in the Agreement for Loans bearing interest at fixed rates, Connecticut Water may prepay the Loans in whole or in part at any time prior to each of the maturity dates of each Loan.


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Credit Rating

On October 28, 2011, Standard & Poor's Ratings Services ("S&P") affirmed its 'A' corporate credit rating on the Company, however, S&P revised the Company's ratings outlook from stable to negative. The negative outlook reflected S&P's expectation of weaker credit metrics as a result of the debt the Company planned to incur to complete the acquisition of Aqua Maine as well as additional near-term debt funding of the Company's capital expenditure program. S&P also indicated that if the Company were to issue a material amount of common equity in the future, this step could lead S&P to revise the outlook to stable. On October 24, 2012, S&P reaffirmed this rating and outlook.

Enterprise Resource Planning Implementation

With the implementation of the Company's new Enterprise Resource Planning ("ERP") system in the first quarter of 2010, the Company delayed customer billings in order to verify the integrity of the system and the accuracy of those bills prior to mailing.

The Company has returned to normal billing and collection processes and does not anticipate delays in billing or collection in subsequent periods. The delay in billing contributed to the increase in the Company's bad debt expense for the years ending December 31, 2010 and 2011, due to the reserve policy based upon aging of the receivables. During 2011, the Company saw progress towards resolving the collection issues, primarily through the ability to charge interest and shut off customers for non-payment and expects continued improvement throughout the remainder of 2012. The Company has experienced a reduction in the age of its accounts receivable in the first nine months 2012 due in part to the collection process changes referred to above.

Stock Plans

The Company offers a dividend reinvestment and stock purchase plan ("DRIP") to all registered shareholders, whereby participants can opt to have dividends directly reinvested into additional shares of the Company. In August 2011, the Board of Directors approved amendments to the DRIP (effective as of January 1, 2012) that permit the Company to add, at the Company's discretion, an "up to 5.00% purchase price discount" feature to the DRIP and are intended to encourage greater shareholder, customer and employee participation in the DRIP. During the nine months ended September 30, 2012 and 2011, plan participants invested $735,000 and $742,000, respectively, in additional shares as part of the DRIP.

From 1999 through 2003, the Company issued stock options to certain employees of the Company. No stock options have been issued by the Company since 2003. During the nine months ended September 30, 2012, 23,235 stock options were exercised, resulting in approximately $631,000 in proceeds to the Company. During the nine months ended September 30, 2011, 5,671 stock options were exercised, resulting in approximately $146,000 in proceeds to the Company.

Future Plans

The Company expects to issue equity at some point between the fourth quarter of 2012 and the third quarter of 2013, depending on market conditions and other Company activities. The Company has a target capital structure that is equally balanced with equity and debt. As noted above, the interim financing utilized in completing the acquisition of Maine Water included two similar sized debt facilities - an $18.0 million fifteen-year fixed loan with an interest rate of 4.09% and a variable rate debt facility with a borrowing of $18.1 million and an initial interest rate of 2.06%. The latter facility is expected to be paid off with the proceeds of the equity issuance. On July 9, 2012, the Company filed a Form S-3 registration statement which detailed the Company's plan to issue up to 1.7 million shares of its common stock. This registration statement was declared effective by the SEC on July 26, 2012. Based on market prices in early July, the proposed maximum aggregate offering price this stock issuance could raise is approximately $50 million.

The Board of Directors approved a $25.1 million construction budget for 2012, net of amounts to be financed by customer advances and contributions in aid of construction. The Company is using a combination of its internally generated funds, borrowing under its available lines of credit, and the funds remaining under our 2011 debt issuance to fund this construction budget.

As the Company looks forward to the remainder of 2012 and 2013, it anticipates continued reinvestment to replace aging infrastructure and to seek recovery through periodic WICA applications. The total cost of that investment is expected to exceed the amount of internally generated funds. The Company expects that it will require external financing over the next two years. In order to maintain a balanced capital structure, we expect to consider both debt and equity issuances. As the capital investment planning process is completed in the coming periods, the Company expects to provide a reasonable range of these potential financings.


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Results of Operations

Three months ended September 30
Net Income for the three months ended September 30, 2012 increased from the same
period in the prior year by $2,240,000 to $5,974,000, which increased earnings
per basic average common share by $0.26 to $0.69.

This increase in Net Income is broken down by business segment as follows (in
thousands):

            Business Segment                September 30, 2012      September 30, 2011      Increase/(Decrease)
Water Activities                           $           5,676       $             3,324     $            2,352
Real Estate Transactions                                 (31 )                     114                   (145 )
Services and Rentals                                     329                       296                     33
Total                                      $           5,974       $             3,734     $            2,240

The increase in the Water Activity segment's Net Income was primarily due to the net effects of the variances listed below:

Revenue

Revenue from our water customers increased by $3,833,000, or 18.6%, to $24,461,000 for the three months ended September 30, 2012 when compared to the same period in 2011. The primary reason for the increase in revenues was the acquisition of Maine Water, which contributed $3,041,000 in additional revenue during the period. Excluding Maine Water, the Company saw an increase in revenue from water customers of $792,000, or approximately 3.8% during the three months ended September 30, 2012. Contributing to the increase in revenue was an increase in residential consumption for the quarter of approximately 3%. The increase in residential consumption was due largely to approximately 9 fewer inches of rainfall in the three months ended September 30, 2012 when compared to the same period in 2011. Generally, the Company expects water usage to increase as rainfall decreases in summer months. Additionally, increased rates in 2012 associated with the recurring WICA surcharge and an increase in customer late payment charges contributed to the revenue increase.

Operation and Maintenance Expense

Operation and Maintenance ("O&M") expense increased by $1,649,000, or 19.1%, for
the three months ended September 30, 2012 when compared to the same period of
2011 primarily due to the acquisition of Maine Water which contributed
$1,278,000 of incremental O&M expense. The following table presents the
components of O&M expense both including and excluding Maine Water (in
thousands):

                                                                                                 Maine Water
                                   Actual September   Actual September   Actual Increase /      September 30,      Adjusted Increase /
       Expense Components            30, 2012 O&M       30, 2011 O&M         (Decrease)           2012 O&M             (Decrease)
Pension                            $          930     $          490     $         440        $           137     $          303
Other benefits                                334                137               197                     53                144
Customer                                      337                223               114                     40                 74
Regulatory commission expense                 113                 73                40                     21                 19
Investor relations                            118                103                15                      -                 15
Labor                                       3,418              2,946               472                    471                  1
Property and liability insurance              264                240                24                     35                (11 )
Maintenance                                   691                638                53                     94                (41 )
Vehicles                                      397                459               (62 )                    2                (64 )
Medical                                       495                482                13                     84                (71 )
Outside services                              349                392               (43 )                  104               (147 )
Other                                       2,827              2,441               386                    237                149
Total                              $       10,273     $        8,624     $       1,649        $         1,278     $          371


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The increase in O&M expenses excluding the incremental expense as a result of the acquisition of Maine Water, was approximately $371,000, or approximately 4.3%, in the third quarter of 2012 when compared to the same period in 2011. The changes in individual items, excluding the impact of Maine Water, are described below:
Pension costs increased over the prior year primarily due to a reduction to the discount rate in 2012;

The increase in Other benefits was primarily attributable to an increase in costs associated with awards made under the Performance Stock Program and costs associated with the Company's non-officer incentive plan;

Customer costs increased in the third quarter of 2012 when compared to the same period of 2011 primarily due to costs associated with meter reading, collection fees and higher postage costs. Offsetting these increases was a decrease to the Company's costs associated with uncollectible accounts as the Company continues to make progress in collecting past due accounts receivables from customers; and

Regulatory commission expense increased due to an increase in statutory fees paid to PURA during the three months ended September 30, 2012 when compared to the same period in 2011. Statutory fees assessed by PURA are outside the control of the Company and are based upon PURA's budget, total revenues of all utilities and the revenue of the utility being assessed. All of those factors increased for the Company during 2012 when compared to 2011.

The increases described above were partially offset by the following decreases to O&M expense:
Medical costs decreased in the third quarter of 2012 when compared to the same period in 2011 due primarily to a reduction in claims filed by plan participants; and

Costs associated with outside services decreased primarily due to a decrease in the amount of temporary labor and consulting services used by the Company in the third quarter of 2012 when compared to the third quarter in 2011.

The Company saw an approximate 23.0% increase in its Depreciation expense from the three months ended September 30, 2012 compared to the same period in 2011. The primary driver of this increase was approximately $377,000 in Depreciation expense attributable to Maine Water. Excluding the impact of Maine Water, the Company's depreciation expense increased by approximately 3.6% for the three months ended September 30, 2012. The remainder of the increase in Depreciation expense is due to higher Utility Plant in Service as of September 30, 2012 compared to September 30, 2011.

Income Tax expense associated with Water Activities decreased by $1,476,000 in the third quarter of 2012 when compared to the same period in 2011 due to lower effective tax rate. Excluding the impact of Maine Water, Income Tax expense decreased by $1,863,000. The primary driver of the lower effective income tax rate was the flow-through benefit associated with the recently completed refinancing of $54.6 million of long-term debt. In addition, in 2011, the Company's effective income tax rate was attributable to a change in pension and post-retirement medical contribution assumptions.

Other Income (Deductions), Net of Taxes increased for the quarter ending September 30, 2012 by $71,000. Excluding the impact of Maine Water, the Company saw an increase of $26,000. The primary driver of this increase was the performance of investments related to the Company's Supplemental Executive Retirement Plan. During the third quarter of 2012, these investments provided income to the Company while in the same period of 2011, these investments returned a loss. Offsetting this benefit was the impact of the Real Estate segment which saw a loss in the third quarter of 2012 due to the effect of certain adjustments to tax reserves related to land sales in previous periods. During the same period of 2011, similar adjustments to tax reserves resulted in a gain.

Total Interest and Debt Expense increased by $738,000 in the third quarter of 2012 when compared to the same period in 2011 due to a December 2011 debt issuance of $24 million, interest costs associated with the debt incurred to acquire Maine Water and interest charged on Maine Water's debt outstanding.

Nine months ended September 30
Net Income for the nine months ended September 30, 2012 increased from the same . . .

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