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CTWS > SEC Filings for CTWS > Form 10-Q on 8-May-2013All 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-May-2013

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, 2012.

Regulatory Matters and Inflation

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 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 accounted for the acquisition in accordance with Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 805 Business Combinations ("FASB ASC 805"), including the purchase price allocation.

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 19, 2012, the Company announced that it had reached an agreement to acquire The Biddeford & Saco Water Company ("BSWC"), pending a vote of BSWC shareholders, approval by the MPUC and the satisfaction of other various conditions. This acquisition added 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 was executed through a stock-for-stock merger transaction valued at approximately $12.0 million. On November 7, 2012, the MPUC approved the transaction and the Company completed the transaction on December 10, 2012. Holders of BSWC common stock received an aggregate of 380,254 shares of the Company's common stock in a tax-free exchange. The Company is accounting for the acquisition in accordance with FASB ASC 805. The Company is still in the process of completing the purchase price allocation as required by FASB ASC 805. See Note 11 for more information.

Public Utility Regulatory Authority Matters

Our Regulated Companies derive their rights and franchises to operate from special state acts that are subject to alteration, amendment or repeal and do not grant us exclusive rights to our service areas. Our franchises are free from burdensome restrictions, are unlimited as to time, and authorize us to sell potable water in all the towns we now serve. There is the possibility that either the State of Connecticut or the State of Maine could attempt to revoke our franchises and allow a governmental entity to take over some or all of our systems. While we would vigorously oppose any such attempts, from time to time such legislation is contemplated.


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The rates we charge our Connecticut water customers are established under the jurisdiction of and are approved by the Connecticut Public Utilities Regulatory Authority (PURA), formerly the Connecticut Department of Public Utility Control. It is our policy to seek rate relief as necessary to enable us to achieve an adequate rate of return. Connecticut Water's allowed return on equity and return on rate base, effective as of July 14, 2010 are 9.75% and 7.32%, respectively. Prior to July 14, 2010, Connecticut Water's allowed return on equity and return on rate base were 10.125% and 8.07%, respectively.

On January 26, 2012, Connecticut Water filed a Water Infrastructure Conservation Act ("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 Connecticut Water's first WICA application and approved the 0.09% reconciliation surcharge from the second application, effective April 1, 2012. As of April 1, 2012, Connecticut Water's cumulative WICA surcharge was 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. As of October 1, 2012, Connecticut Water's cumulative WICA surcharge was 5.73%.

On January 25, 2013, Connecticut Water filed a WICA application with the PURA requesting an additional 1.08% surcharge to customer bills related to approximately $6.5 million spending on WICA projects. This application also reduced the surcharge by 0.09% for the prior year reconciliation adjustment which expires April 1, 2013. On January 30, 2013, Connecticut Water filed for a 0.10% reconciliation adjustment for the 2012 shortfall in WICA, to become effective April 1, 2013. On March 25, 2013, the PURA approved an additional 1.06% surcharge, effective April 1, 2013. Additionally, on March 27, 2013, the PURA approved a 0.10% reconciliation adjustment, effective April 1, 2013. As of April 1, 2013, Connecticut Water's cumulative WICA surcharge is 6.80%.

In April 2013, Maine Water filed for rate increases in three of its divisions, totaling approximately $94,000 in additional revenue. The primary drivers for the requested increases are due to declining revenues and increased costs. The applications are currently under review at the MPUC and a final decision is expected within nine months.

The rates we charge our Maine water customers are established under the jurisdiction of and are approved by the MPUC. It is our policy to seek rate relief as necessary to enable us to achieve an adequate rate of return. Maine Water's average allowed return on equity and return on rate base, as of December 31, 2012 are 10.00% and 8.31%, respectively. BSWC's allowed return on equity, as of December 31, 2012 is 10.00%.

The Maine Legislature is currently in the process of formalizing a Temporary Surcharge for Infrastructure Replacement and Repairs, a WICA-like mechanism that will allow for expedited recovery of infrastructure improvements. The Company expects that Maine Water and BSWC will be able to take advantage of the surcharge in late 2013 or early 2014.

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, Maine Water and BSWC, 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, 2012.

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, 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


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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 2012 Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

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 segment to increase in 2013 over 2012 levels, based, in part, on the acquisition of BSWC, 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 2013 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, 2012 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.

Borrowing Facilities

On June 30, 2009, the Company entered into a $15 million line of credit agreement with CoBank, ACB, which was amended in May 2010, July 2011 and September 2012 and is currently scheduled to expire 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 BSWC, the total lines of credit available to the Company increased to $37.25 million, due to BSWC's $2.25 million line of credit expiring June 30, 2013. Interim Bank Loans Payable at March 31, 2013 and December 31, 2012 was approximately $1.0 million and $1.7 million, respectively, and represents the outstanding aggregate balances on these lines of credit. The Company used a portion of the $47.5 million of net proceeds of its December 2012 equity issuance to pay down a portion of its outstanding balances on these lines of credit. As of March 31, 2013, the Company had $36.25 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.

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. On December 12, 2012, the Company issued approximately 1.7 million shares of common stock and used a portion of the proceeds to pay off the second Term Note. See "December 2012 Equity Issuance" below for more detail.


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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 sought 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 would 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.

On December 7, 2012, Maine Water entered into an amended and restated Master Loan Agreement with CoBank, pursuant to which CoBank loaned Maine Water $1,965,000, which proceeds were used by Maine Water to reimburse itself for the repayment in full on November 29, 2012 of all principal, accrued interest, premiums, surcharges and other amounts owed by Maine Water pursuant to its long-term bonds previously issued in 1999.

On March 5, 2013, Connecticut Water and CoBank entered into a Promissory Note and Single Advance Term Loan Supplement to the MLA (the "Note") in which CoBank agreed to make an additional Loan to Connecticut Water in an aggregate principal amount of up to $14,550,000, with a maturity date of March 4, 2033.
Additionally, the Company entered into an Amendment to the Guarantee dated March 5, 2013 (the "Guarantee Amendment"), pursuant to which the Company agreed to guarantee the payment of certain of Connecticut Water's obligations under the Note pursuant to the same terms of the Guarantee.

Credit Rating

On April 15, 2013, Standard & Poor's Ratings Services ("S&P") affirmed its 'A'/Negative corporate credit rating and outlook on the Company. In its report S&P, commented on the material improvement of the Company's debt-to-capital ratio (52.1% at December 31, 2012 compared to 59.1% at December 31, 2011). S&P also noted that cash flows measures are expected to improve due to increased revenue from infrastructure surcharges and rate case increases. The Company's A rating has been in place since its initial rating in 2003.

Stock Plans

The Company offers a dividend reinvestment and stock purchase plan ("DRIP") to all registered shareholders, and to the customers and employees of our regulated water companies, 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 three months ended March 31, 2013 and 2012, plan participants invested $393,000 and $354,000, 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 three months ended March 31, 2013, no stock options were exercised. During the three months ended March 31, 2012, 3,431 stock options were exercised, resulting in approximately $88,000 in proceeds to the Company.

December 2012 Equity Issuance

On December 12, 2012, the Company completed an underwritten public offering of 1,696,250 shares of its common stock at a price to the public of $29.25 per share, including overallotments. Wells Fargo Securities served as sole book-runner for the offering. The offering was made pursuant to a "shelf" registration statement (including a prospectus) previously filed with and


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declared effective by the Securities and Exchange Commission in July 2012. The Company used the net proceeds of approximately $47.5 million to repay approximately $39 million of our short-term indebtedness, to fund capital expenditures and for other general corporate purposes.

The Board of Directors approved a $31.3 million construction budget for 2013, net of amounts to be financed by customer advances and contributions in aid of construction. The Company is and will use some combination of its internally generated funds, remaining proceeds from its December 2012 equity issuance, 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 2013 and 2014, it anticipates continued reinvestment to replace aging infrastructure and to seek recovery through periodic WICA applications in Connecticut and a similar surcharge proposed in the Maine Legislature. The total cost of that investment may exceed the amount of internally generated funds. If so, the Company will consider external financing. In order to maintain a balanced capital structure, we would 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.

Results of Operations

Three months ended March 31
Net Income for the three months ended March 31, 2013 increased from the same
period in the prior year by $703,000 to $2,613,000, which increased earnings per
basic average common share by $0.02 to $0.24.

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

    Business Segment        March 31, 2013      March 31, 2012      Increase/(Decrease)
Water Activities           $          2,227    $          1,560    $                 667
Real Estate Transactions                  -                   -                        -
Services and Rentals                    386                 350                       36
Total                      $          2,613    $          1,910    $                 703

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 $1,189,000, or 6.4%, to $19,729,000 for the three months ended March 31, 2013 when compared to the same period in 2012. The primary reason for the increase in revenues was the acquisition of BSWC, which contributed $929,000 in additional revenue during the period. Excluding BSWC, the Company saw an increase in revenue from water customers of $260,000, or approximately 1.4% during the three months ended March 31, 2013. The primary driver for the increase in revenue in 2013 was the increased rates in 2013 associated with the recurring WICA surcharge, partially offset by decreases to revenues received from residential and commercial customers due primarily to declining usage when compared to the previous period.


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Operation and Maintenance Expense

Operation and Maintenance ("O&M") expense increased by $743,000, or 7.7%, for
the three months ended March 31, 2013 when compared to the same period of 2012
primarily due to the acquisition of BSWC which contributed $834,000 of
incremental O&M expense. The following table presents the components of O&M
expense both including and excluding BSWC (in thousands):

                                   Actual March     Actual March       Actual Increase /      BSWC March 31,     Adjusted Increase /
      Expense Components           31, 2013 O&M     31, 2012 O&M          (Decrease)             2013 O&M            (Decrease)
Customer                          $        436     $         225     $          211          $           47     $          164
Pension                                    997               857                140                       -                140
Outside services                           563               331                232                     101                131
Utility costs                            1,098               980                118                      63                 55
Other benefits                             310               372                (62 )                     -                (62 )
Water treatment (including
chemicals)                                 611               629                (18 )                    64                (82 )
Post-retirement medical                    163               251                (88 )                     -                (88 )
Payroll                                  3,525             3,322                203                     306               (103 )
Medical                                    631               612                 19                     148               (129 )
Amston Lake water quality
monitoring costs (non-labor)                 -               135               (135 )                     -               (135 )
Other                                    2,044             1,921                123                     105                 18
Total                             $     10,378     $       9,635     $          743          $          834     $          (91 )

The decrease in O&M expenses excluding the incremental expense as a result of the acquisition of BSWC, was approximately $91,000, or approximately 0.9%, in the first quarter of 2013 when compared to the same period in 2012. The changes in individual items, excluding the impact of BSWC, are described below:
Payroll costs decreased primarily due to a decrease in the number employees at March 31, 2013 when compared to March 31, 2012, excluding BSWC employees, and the capitalization of employee time related to an ongoing procurement project that began in the first quarter of 2013. This project is to designed to help reduce the costs of water infrastructure projects in future periods;

Medical costs decreased in the first quarter of 2013 when compared to the same period in 2012 due primarily to a reduction in claims filed by plan participants; and

Early in the first quarter of 2012, the Company received notification of elevated copper levels observed in the homes of certain customers in our Amston Lake system. As a result, Connecticut Water incurred costs associated with the monitoring of water sources and customer homes. The copper levels returned to normal during the latter part of the first quarter of 2012.

The decreases described above were partially offset by the following increases to O&M expense:
Customer costs increased in 2013 primarily due to an increase in bad debt expense and an increase in postage costs for customer mailings;

The increase in Pension costs was attributable primarily to a decrease in the discount rate used in determining net periodic benefit costs in 2013; and

Outside services expense increased primarily due to an increase consulting fees related to the organizational design portion of the Company's ongoing procurement project.

The Company saw an approximate 13.3% increase in its Depreciation expense from the three months ended March 31, 2013 compared to the same period in 2012. The primary driver of this increase was approximately $168,000 in Depreciation expense attributable to BSWC. Excluding the impact of BSWC, the Company's depreciation expense increased by approximately 6.2% for the three months ended March 31, 2013. The remainder of the increase in Depreciation expense was due to higher Utility Plant in Service as of March 31, 2013 compared to March 31, 2012.

Income Tax expense associated with Water Activities increased by $149,000 in the first quarter of 2013 when compared to the same period in 2012 due to higher pre-tax net income. Excluding the impact of BSWC, Income Tax expense increased by $269,000.


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Other Income (Deductions), Net of Taxes increased for the quarter ending March 31, 2013 by $116,000, with BSWC contributing $1,000 to the increase. The primary driver of this increase was the reduction in acquisition related costs in 2013 and an increase in patronage income from one of our banking partners and higher earnings from our unregulated company, New England Water Utility Services.

Total Interest and Debt Expense decreased by $749,000 in the first quarter of 2013 when compared to the same period in 2012 due to an increase in the patronage related to interest received from one of our banking partners and a decrease in Interest on Long-Term Debt due to the refinancing of approximately $54.6 million in long-term debt in the fourth quarter of 2012 and the repayment of approximately $18.0 million in debt used to acquire Maine Water.

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