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

Show all filings for CONNECTICUT WATER SERVICE INC / CT

Form 10-Q for CONNECTICUT WATER SERVICE INC / CT


8-Nov-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.

General Information

Acquisitions

Effective January 1, 2012, Connecticut Water Service, Inc. (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 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 in Part I, Item1 for more information.

UCONN Proposal

Beginning in June 2011, the University of Connecticut ("UCONN"), in partnership with the Town of Mansfield, initiated a process to identify and implement actions to secure a long-term water solution to meet the water supply needs for the University and the Town of Mansfield. On June 7, 2013, Connecticut Water submitted information to the University and the Town on its proposal to bring a reliable supply of water to the University's Storrs campus and to residents of Mansfield. Connecticut Water's submission for this project was made as part of the Environmental Impact Evaluation ("EIE") process under the Connecticut Environmental Policy Act.


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As detailed in its proposal, Connecticut Water proposes to bring up to 2 million gallons of water a day with a water main extension of approximately 5 miles from its water system in the Town of Tolland to Mansfield to meet the University campus and the Town of Mansfield's water supply needs. On August 7, 2013, the Board of Trustees of the University voted to recommend Connecticut Water's proposal. On September 16, 2013, the State's Office of Policy and Management issued their approval of the Record of Decision of the EIE, allowing the University to proceed to implement the water supply solution.

On October 23, 2013, Connecticut Water entered into a non-binding letter of intent with UCONN to provide a long-term supply of potable water for UCONN's Storrs campus facilities (the "Project"). The UCONN Letter of Intent describes the rights and obligations of the parties related to the Project and also sets forth the principal terms and conditions under which the Company will supply water to UCONN for the Project.

The proposed rights and obligations of the parties, and other terms and conditions described in the Letter of Intent are not intended to be legally binding on either of the parties. The parties have agreed that they will only be bound if and when a definitive water supply and management agreement has been negotiated, approved and executed by the parties.

The Company and UCONN expect to negotiate and execute their definitive agreement for the Project on or before December 31, 2013, unless otherwise extended by mutual agreement of the parties. The definitive agreement will be subject to the requirements of the Project's EIE and record of decision, as approved by the Office of Policy and Management that identified the Company as the preferred option to supply UCONN and the Town of Mansfield, Connecticut with up to 2.2 million gallons of water per day over the next 50 years. The Company is responsible for obtaining any required regulatory permits, licenses and approvals to implement the water supply solution, including but not limited to those from PURA, the Connecticut Department of Energy and Environmental Protection and the Connecticut Department of Public Health.

On October 29, 2013, Connecticut Water and the Town of Mansfield, Connecticut entered into a non-binding Letter of Intent for Connecticut Water to provide water utility service to the Town. The Mansfield Letter of Intent provides the framework for necessary contractual agreements for Connecticut Water to serve the Mansfield community. Connecticut Water and the Town are working together towards finalizing a definitive written agreement by December 31, 2013, unless otherwise extended by mutual agreement of the parties.

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.

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.

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 expired April 1, 2013. On January 30, 2013, Connecticut Water


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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 was 6.80%.

On July 25, 2013, Connecticut Water filed a WICA application with the PURA requesting an additional 1.09% surcharge to customers' bills, representing approximately $5.6 million in WICA related projects. On September 18, 2013 the PURA approved the 1.09% surcharge with the new rates becoming effective on October 1, 2013. As of October 1, 2013, the cumulative WICA surcharge was 7.89%.

On June 28, 2013, Connecticut Water entered into a settlement agreement with the Office of the Consumer Counsel of the State of Connecticut and the Office of the Attorney General for the State of Connecticut (the "Settlement Agreement"), whereby Connecticut Water would adjust the water rates charged to its customers effective April 1, 2014 in accordance with the elements of the Settlement Agreement (the "Connecticut Water Rate Reduction Plan"). On July 1, 2013, Connecticut Water submitted an application to the PURA seeking formal approval of the Settlement Agreement.

The Settlement Agreement contemplates that Connecticut Water will adopt temporary and proposed regulations issued by the Internal Revenue Service ("IRS") that allows the Company to adopt an alternative method for determining how expenditures related to tangible property can be treated for federal tax purposes for tax years beginning on or after January 1, 2012. This tax accounting method change treats certain expenditures that the Company historically capitalized for tax purposes, as a deductible repair expense on its tax return. The adoption of the tax accounting method change allowed Connecticut Water to record a favorable "catch up adjustment" on the Company's consolidated 2012 federal tax return which was filed in September 2013. The Company filed for a tax refund of approximately $13.6 million by carrying back the net operating loss generated from this adjustment.

The Settlement Agreement includes, as a result of negotiated compromise of the parties' respective positions, the following key elements related to the Connecticut Water Rate Reduction Plan:

1) Connecticut Water crediting its water customers with the amount of the catch up adjustment plus the amount by which 2012 federal income taxes are reduced by the repair deduction (the deduction amount filed on the Company's 2012 federal tax return was approximately $45 million) in order to offset an anticipated rate increase arising from the revenue adjustment mechanism authorized by the State of Connecticut in Public Act No. 13-78 with any associated change in rates to also be reflected on Connecticut Water customers' bills as of April 1, 2014;

2) Resetting Connecticut Water's adjustment under Connecticut's WICA mechanism to zero by integrating the present WICA surcharge of 7.89% into Connecticut Water's base rates; and

3) Connecticut Water agreeing not to file for a general rate increase (except under extraordinary circumstances outside Connecticut Water's control) for new rates to be effective any sooner than October 1, 2015.

In the Settlement Agreement, the parties also requested that PURA approve an accounting treatment for Connecticut Water to: 1) allow for the deferral of the tax refund described above and a credit of the tax benefit to customers over a proposed two-year period through a credit on water bills issued starting April 1, 2014 and 2) defer on the balance sheet as a regulatory asset or liability, for later crediting to or collection from customers of the amount by which actual revenues deviate from the revenues allowed in Connecticut Water's in most recent general rate proceedings, including WICA proceedings (the "Revenue Adjustment Mechanism" or "RAM"). The RAM removes the financial disincentive for water utilities to develop and implement effective water conservation programs.

On August 30, 2013, the PURA issued a final decision approving the Settlement Agreement. The Company will begin to issue a credit on customers' bills of approximately 8% beginning April 1, 2014.

Connecticut Water's allowed revenues for the nine months ended September 30, 2013, as approved by PURA during our 2010 general rate case and including subsequently approved WICA surcharges, are approximately $58.3 million. Through normal billing and accrual of unbilled water usage for the nine months ended September 30, 2013 revenue for Connecticut Water would have been approximately $55.5 million had the RAM not been implemented effective January 1, 2013. As a result of the implementation of the RAM, Connecticut Water recorded $2.8 million in additional revenue for the nine months ended September 30, 2013. The additional revenue generated approximately $0.15 in additional earnings per share in the nine months ended September 30, 2013. Based on historical analysis, the Company believes that approximately 23% of Connecticut Water's


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annual revenue will be earned in the final three months of 2013.

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 September 30, 2013 were 10.00% and 8.31%, respectively. BSWC's allowed return on equity, as of September 30, 2013, was 10.00%.

In April 2013, Maine Water filed for rate increases in three of its divisions, totaling approximately $94,000 in additional revenue, driven primarily by dropping consumption and small expense increases. On July 9, 2013, the MPUC approved rate increases totaling $88,000 for these divisions, to be effective July 1, 2013. In June 2013, Maine Water filed for rate increases in three additional divisions, totaling approximately $554,000 in additional revenue, driven primarily by capital expenditures, declining consumption and small expense increases. These applications are currently under review at the MPUC, and a final decision is expected within nine months of the initial filing.

Effective June 2013, a Water Infrastructure Surcharge ("WISC") is available in Maine that allows for expedited recovery of investment in water system infrastructure replacement, both treatment and distribution. The Company expects that Maine Water and BSWC will begin to use this in late 2013 or early 2014.

On September 3, 2013, an application was filed with the MPUC to merge Maine Water and BSWC, with Maine Water as the surviving entity. This application is currently under review by the MPUC, and a decision is expected before the end of 2013.

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 (including the Revenue Adjustment Mechanism), 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 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, the outcome of the review of the Company's Connecticut state tax filings by the Connecticut Department of Revenue Services, and the timing and adequacy of rate relief when requested, from time to time, by our regulated water companies.


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The Company expects Net Income from its Water Activities segment to increase in 2013 over 2012 levels, based, in part, on the implementation of the RAM, the adoption of the tax accounting method change and the continued utilization of WICA, 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" below 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 ("CoBank"), which was amended in May 2010, July 2011 and September 2012 and is currently scheduled to expire on July 1, 2014. The Company maintains an additional line of credit of $20 million, with an expiration date of June 30, 2014. On June 30, 2013, the Company allowed BSWC's $2.25 million line of credit to expire. As of September 30, 2013, the total lines of credit available to the Company was $35.0 million. Interim Bank Loans Payable at September 30, 2013 and December 31, 2012 was approximately $1.3 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 September 30, 2013, the Company had $33.7 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.

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. 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. 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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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. Connecticut Water used substantially all of the proceeds of the Loans to refinance the 2007 A Series bonds outstanding.

On June 3, 2013, Maine Water completed the issuance of $1,409,888 aggregate principal amount of its First Mortgage Bonds, Series V, 1.0% due April 1, 2033 (the "Bonds"). The Bonds were issued by Maine Water to the Maine Municipal Bond Bank (the "Bank") and the proceeds of the issuance were loaned (the "Loan") by the Bank to Maine Water pursuant to a Loan Agreement by and between Maine Water and the Bank dated as of June 3, 2013 (the "Loan Agreement"). The proceeds of the Loan will be used by Maine Water to fund various water facilities projects.

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 nine months ended September 30, 2013 and 2012, plan participants invested $1,209,000 and $735,000, 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, 2013, no stock options were exercised. During the nine months ended September 30, 2012, 5,671 stock options were exercised, resulting in approximately $631,000 in proceeds to the Company.

December 2012 Equity Issuance

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