10-Q 1 ctws10qq22013.htm 10-Q CTWS 10Q Q2 2013


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2013 or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM

TO
Commission File Number 0-8084
Connecticut Water Service, Inc.
(Exact name of registrant as specified in its charter)
Connecticut
(State or other jurisdiction of
incorporation or organization)
 
06-0739839
(I.R.S. Employer Identification No.)
 
 
 
93 West Main Street, Clinton, CT
(Address of principal executive offices)
 
06413
(Zip Code)

(860) 669-8636
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x        No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x        No ¨

Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer x
Non-accelerated filer o
(Do not check if smaller reporting company)
 
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨        No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date
11,003,512
Number of shares of common stock outstanding, July 31, 2013
(Includes 171,151 common stock equivalent shares awarded under the Performance Stock Programs) 



CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
 
Financial Report
June 30, 2013
 
TABLE OF CONTENTS

Part I, Item 1:  Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exhibit 31.1
Exhibit 31.2
Exhibit 32
Exhibit 101.INS
Exhibit 101.SCH
Exhibit 101.CAL
Exhibit 101.DEF
Exhibit 101.LAB
Exhibit 101.PRE



CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share data)
ASSETS
 
June 30,
2013
 
December 31,
2012
Utility Plant
 
$
624,002

 
$
611,787

Construction Work in Progress
 
8,597

 
7,734

 
 
632,599

 
619,521

Accumulated Provision for Depreciation
 
(177,160
)
 
(171,610
)
Net Utility Plant
 
455,439

 
447,911

Other Property and Investments
 
6,692

 
6,394

Cash and Cash Equivalents
 
7,548

 
13,150

Accounts Receivable (Less Allowance, 2013 - $996; 2012 - $1,058)
 
12,136

 
11,526

Accrued Unbilled Revenues
 
8,275

 
7,233

Materials and Supplies, at Average Cost
 
1,766

 
1,629

Prepayments and Other Current Assets
 
3,357

 
2,824

Total Current Assets
 
33,082

 
36,362

Restricted Cash
 
9,937

 
9,820

Unamortized Debt Issuance Expense
 
7,109

 
7,411

Unrecovered Income Taxes - Regulatory Asset
 
13,553

 
9,871

Pension Benefits - Regulatory Asset
 
17,251

 
18,319

Post-Retirement Benefits Other Than Pension - Regulatory Asset
 
3,097

 
3,022

Goodwill
 
31,685

 
31,685

Deferred Charges and Other Costs
 
8,251

 
8,180

Total Regulatory and Other Long-Term Assets
 
90,883

 
88,308

Total Assets
 
$
586,096

 
$
578,975

CAPITALIZATION AND LIABILITIES
 
 

 
 

Common Stockholders' Equity:
 
 

 
 

Common Stock Without Par Value:
 
 

 
 

Authorized - 25,000,000 Shares - Issued and Outstanding:
 
 

 
 

     2013 - 11,001,715; 2012 - 10,939,486
 
$
136,005

 
$
134,873

Retained Earnings
 
53,395

 
51,804

Accumulated Other Comprehensive Loss
 
(1,207
)
 
(1,328
)
Common Stockholders' Equity
 
188,193

 
185,349

Preferred Stock
 
772

 
772

Long-Term Debt
 
178,731

 
178,475

Total Capitalization
 
367,696

 
364,596

Current Portion of Long-Term Debt
 
1,388

 
1,304

Interim Bank Loans Payable
 
134

 
1,660

Accounts Payable and Accrued Expenses
 
7,326

 
10,016

Accrued Taxes
 
199

 

Accrued Interest
 
750

 
889

Other Current Liabilities
 
2,065

 
2,008

Total Current Liabilities
 
11,862

 
15,877

Advances for Construction
 
31,566

 
31,030

Contributions in Aid of Construction
 
77,349

 
77,372

Deferred Federal and State Income Taxes
 
43,947

 
40,869

Unfunded Future Income Taxes
 
13,119

 
8,992

Long-Term Compensation Arrangements
 
38,067

 
36,430

Unamortized Investment Tax Credits
 
1,454

 
1,490

Other Long-Term Liabilities
 
1,036

 
2,319

Total Long-Term Liabilities
 
206,538

 
198,502

Commitments and Contingencies
 

 

Total Capitalization and Liabilities
 
$
586,096

 
$
578,975

The accompanying footnotes are an integral part of these condensed consolidated financial statements.

3


CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Three Months Ended June 30, 2013 and 2012
(Unaudited)
(In thousands, except per share amounts)
 
2013
 
2012
Operating Revenues
$
22,545

 
$
21,348

Operating Expenses
 
 
 
Operation and Maintenance
10,357

 
10,076

Depreciation
2,600

 
2,392

Income Taxes
2,519

 
2,167

Taxes Other Than Income Taxes
1,810

 
1,702

Total Operating Expenses
17,286

 
16,337

Net Operating Revenues
5,259

 
5,011

Other Utility Income, Net of Taxes
179

 
188

Total Utility Operating Income
5,438

 
5,199

Other Income (Deductions), Net of Taxes
 
 
 
Gain on Real Estate Transactions

 
982

Non-Water Sales Earnings
376

 
333

Allowance for Funds Used During Construction
76

 
79

Other
(111
)
 
(298
)
Total Other Income, Net of Taxes
341

 
1,096

Interest and Debt Expense
 
 
 
Interest on Long-Term Debt
1,791

 
1,927

Other Interest (Income) Charges, Net
(157
)
 
110

Amortization of Debt Expense and Premium, Net
(165
)
 
95

Total Interest and Debt Expense
1,469

 
2,132

Net Income
4,310

 
4,163

Preferred Stock Dividend Requirement
10

 
10

Net Income Applicable to Common Stock
$
4,300

 
$
4,153

Weighted Average Common Shares Outstanding:
 
 
 
Basic
10,819

 
8,667

Diluted
10,989

 
8,805

Earnings Per Common Share:
 
 
 
Basic
$
0.40

 
$
0.48

Diluted
$
0.39

 
$
0.47

Dividends Per Common Share
$
0.2425

 
$
0.2375


The accompanying footnotes are an integral part of these condensed consolidated financial statements.


4


CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Six Months Ended June 30, 2013 and 2012
(Unaudited)
(In thousands, except per share amounts)

 
 
2013
 
2012
Operating Revenues
 
$
42,274

 
$
39,888

Operating Expenses
 
 

 
 

Operation and Maintenance
 
20,735

 
19,711

Depreciation
 
5,304

 
4,779

Income Taxes
 
3,647

 
3,146

Taxes Other Than Income Taxes
 
3,970

 
3,690

Total Operating Expenses
 
33,656

 
31,326

Net Operating Revenues
 
8,618

 
8,562

Other Utility Income, Net of Taxes
 
385

 
364

Total Utility Operating Income
 
9,003

 
8,926

Other Income (Deductions), Net of Taxes
 
 

 
 

Gain on Real Estate Transactions
 

 
982

Non-Water Sales Earnings
 
762

 
683

Allowance for Funds Used During Construction
 
130

 
135

Other
 
(172
)
 
(441
)
Total Other Income, Net of Taxes
 
720

 
1,359

Interest and Debt Expense
 
 

 
 

Interest on Long-Term Debt
 
3,578

 
3,847

Other Interest (Income) Charges, Net
 
(700
)
 
187

Amortization of Debt Expense and Premium, Net
 
(78
)
 
178

Total Interest and Debt Expense
 
2,800

 
4,212

Net Income
 
6,923

 
6,073

Preferred Stock Dividend Requirement
 
19

 
19

Net Income Applicable to Common Stock
 
$
6,904

 
$
6,054

Weighted Average Common Shares Outstanding:
 
 

 
 

Basic
 
10,811

 
8,659

Diluted
 
10,977

 
8,793

Earnings Per Common Share:
 
 
 
 

Basic
 
$
0.64

 
$
0.70

Diluted
 
$
0.63

 
$
0.69

Dividends Per Common Share
 
$
0.4850

 
$
0.4750


The accompanying footnotes are an integral part of these condensed consolidated financial statements.


5


CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Three Months Ended June 30, 2013 and 2012
(Unaudited)
(In thousands)

 
2013
 
2012
Net Income
$
4,310

 
$
4,163

Other Comprehensive Income/(Loss), net of tax
 

 
 

Qualified Cash Flow Hedging Instrument Income, net of tax expense of $0 and $0 in 2013 and 2012
1

 
1

Reclassification to Pension and Post-Retirement Benefits Other than Pension, net of tax (expense) benefit of $(28) in 2013 and $19 in 2012
92

 
(29
)
Unrealized gain (loss) on investments, net of tax (expense) benefit of $(3) in 2013 and $19 in 2012
5

 
(30
)
Other Comprehensive Income/(Loss), net of tax
98

 
(58
)
Comprehensive Income
$
4,408

 
$
4,105





CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Six Months Ended June 30, 2013 and 2012
(Unaudited)
(In thousands)

 
2013
 
2012
Net Income
$
6,923

 
$
6,073

Other Comprehensive Income/(Loss), net of tax

 

 
 
Qualified Cash Flow Hedging Instrument Income, net of tax expense of $0 and $0 in 2013 and 2012
1

 
1

Reclassification to Pension and Post-Retirement Benefits Other Than Pension, net of tax (expense) benefit of $(45) in 2013 and $31 in 2012
67

 
(35
)
Unrealized gain on investments, net of tax expense of $(35) in 2013 and $(21) in 2012
53

 
31

Other Comprehensive Income/(Loss), net of tax
121

 
(3
)
Comprehensive Income
$
7,044

 
$
6,070



The accompanying footnotes are an integral part of these condensed consolidated financial statements. 

6


CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF RETAINED EARNINGS
For the Three Months Ended June 30, 2013 and 2012
(Unaudited)
(In thousands, except per share amounts)

 
2013
 
2012
Balance at Beginning of Period
$
51,756

 
$
46,482

Net Income
4,310

 
4,163

 
56,066

 
50,645

Dividends Declared:
 

 
 

Cumulative Preferred, Class A, $0.20 per share
3

 
3

Cumulative Preferred, Series $0.90, $0.225 per share
7

 
7

Common Stock - 2013 $0.2425 per share; 2012 $0.2375 per share
2,661

 
2,091

 
2,671

 
2,101

Balance at End of Period
$
53,395

 
$
48,544




CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF RETAINED EARNINGS
For the Six Months Ended June 30, 2013 and 2012
(Unaudited)
(In thousands, except per share amounts)


 
2013
 
2012
Balance at Beginning of Period
$
51,804

 
$
46,669

Net Income
6,923

 
6,073

 
58,727

 
52,742

Dividends Declared:
 

 
 

Cumulative Preferred, Class A, $0.40 per share
6

 
6

Cumulative Preferred, Series $0.90, $0.45 per share
13

 
13

Common Stock - 2013 $0.485 per share; 2012 $0.475 per share
5,313

 
4,179

 
5,332

 
4,198

Balance at End of Period
$
53,395

 
$
48,544



The accompanying footnotes are an integral part of these condensed consolidated financial statements.


7


CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 2013 and 2012
(Unaudited)
(In thousands)
 
2013
 
2012
Operating Activities:
 
 
 
Net Income
$
6,923

 
$
6,073

Adjustments to Reconcile Net Income to Net Cash Provided by
 

 
 

Operating Activities:
 

 
 

Deferred Revenues
119

 
119

Provision for Deferred Income Taxes and Investment Tax Credits, Net
3,485

 
1,005

Allowance for Funds Used During Construction
(130
)
 
(134
)
Depreciation (including $343 and $161 in 2013 and 2012 charged to other accounts)
5,647

 
4,940

Gain from Sale of Land

 
(982
)
Change in Assets and Liabilities:
 

 
 

Increase in Accounts Receivable and Accrued Unbilled Revenues
(1,652
)
 
(2,064
)
Increase in Prepayments and Other Current Assets
(673
)
 
(294
)
Decrease in Other Non-Current Items
1,338

 
2,196

Decrease in Accounts Payable, Accrued Expenses and Other Current Liabilities
(1,715
)
 
(595
)
Total Adjustments
6,419

 
4,191

Net Cash and Cash Equivalents Provided by Operating Activities
13,342

 
10,264

Investing Activities:
 

 
 

Company Financed Additions to Utility Plant
(13,428
)
 
(11,085
)
Advances from Others for Construction
(245
)
 
(61
)
Net Additions to Utility Plant Used in Continuing Operations
(13,673
)
 
(11,146
)
Purchase of water systems, net of cash acquired

 
(36,340
)
Proceeds from the Sale of Land

 
1,450

Release of Restricted Cash
1,295

 
3,321

Net Cash and Cash Equivalents Used in Investing Activities
(12,378
)
 
(42,715
)
Financing Activities:
 

 
 

Proceeds from Interim Bank Loans
134

 
24,271

Repayment of Interim Bank Loans
(1,660
)
 
(21,372
)
Proceeds from the Issuance of Long-Term Debt
14,550

 
36,088

Costs to Issue Long-Term Debt and Common Stock
(31
)
 
(180
)
Proceeds from Issuance of Common Stock
797

 
703

Proceeds from the Exercise of Stock Options

 
88

Repayment of Long-Term Debt Including Current Portion
(15,269
)
 
(625
)
Advances from Others for Construction
245

 
61

Cash Dividends Paid
(5,332
)
 
(4,198
)
Net Cash and Cash Equivalents (Used in) Provided by Financing Activities
(6,566
)
 
34,836

Net (Decrease) Increase in Cash and Cash Equivalents
(5,602
)
 
2,385

Cash and Cash Equivalents at Beginning of Period
13,150

 
1,012

Cash and Cash Equivalents at End of Period
$
7,548

 
$
3,397

Non-Cash Investing and Financing Activities:
 

 
 

Non-Cash Contributed Utility Plant
$
346

 
$
284

Short-term Investment of Bond Proceeds Held in Restricted Cash
$
9,937

 
$
12,613

Supplemental Disclosures of Cash Flow Information:
 

 
 

Cash Paid for:
 

 
 

Interest
$
3,118

 
$
3,806

State and Federal Income Taxes
$
1,500

 
$
2,706

The accompanying footnotes are an integral part of these condensed consolidated financial statements.

8


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.
Basis of Preparation of Financials

The condensed consolidated financial statements included herein have been prepared by Connecticut Water Service, Inc. and Subsidiaries (the “Company”), pursuant to the rules and regulations of the Securities and Exchange Commission and reflect all adjustments that are of a normal recurring nature which are, in the opinion of management, necessary to a fair statement of the results for interim periods.  The Company’s primary operating subsidiaries are: The Connecticut Water Company (“Connecticut Water”), The Maine Water Company (“Maine Water”) and the Biddeford & Saco Water Company ("BSWC").  Certain information and footnote disclosures have been omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading.  The Condensed Consolidated Balance Sheet at December 31, 2012 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  It is suggested that these condensed consolidated financial statements be read in conjunction with the financial statements and the notes thereto included in the Company’s latest Annual Report on Form 10-K for the year ended December 31, 2012 and as updated in the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2013.

Effective January 1, 2013, the Company began recording an accrual for future patronage refunds from a banking partner based on past history, where in prior years the refund was recorded when received. The Company received $588,000 in patronage distribution during the first quarter of 2013 which related to the year ended December 31, 2012. The Company has determined that changing the accounting to an accrual basis in 2013 is appropriate. The Company believes that the amounts received and recorded in prior periods were not material to the Company's consolidated results of operations or consolidated financial position.

During the second quarter of 2013, the Company recognized that it was not properly amortizing the fair value of debt that was recorded as part of the Company's acquisitions of Maine Water and BSWC. As a result, in the second quarter of 2013, the Company recorded $169,000 and $85,000 of amortization into income relating to year ended December 31, 2012 and the first quarter of 2013, respectively. The Company believes that the amounts recorded were not material to the Company's consolidated results of operations or consolidated financial position.

Certain reclassifications have been made to the 2012 Condensed Consolidated Statement of Cash Flows to conform previously reported data to the current presentation.

The results for interim periods are not necessarily indicative of results to be expected for the year since the consolidated earnings are subject to seasonal factors.

Regulatory Matters

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 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 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. Connecticut Water expects the PURA to issue a decision on the WICA application during the third quarter of 2013 with the new rates becoming effective on October 1, 2013.

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

9


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 by PURA 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 will treat 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 will allow Connecticut Water to record a favorable “catch up adjustment” on the Company's consolidated 2012 federal tax return to be filed in September 2013. The Company anticipates that it will be entitled to receive a significant tax refund 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 (although the total amount of these deductions will not be known until the Company's 2012 tax return is complete, the Company currently estimates the amount of the deduction will be approximately $10 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 (expected to be approximately 7.9% effective as of October 1, 2013) 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 are also requesting 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 for later crediting to or collection from customers of the amount by which actual revenues deviate from the revenues allowed Connecticut Water's in most recent general rate proceeding.

The Agreement provides that, if the PURA does not fully approve the Agreement in its entirety, it shall be deemed withdrawn. Accordingly, the Agreement has no operative effect unless and until it is approved by the PURA.

The parties to the Settlement Agreement have asked the PURA to issue a decision as soon as possible but not later than August 31, 2013; however, the Company is not able to predict with certainty the ultimate timing of the PURA's final action on the Settlement Agreement. No assurance can be given that the PURA will approve the Agreement and permit some or all of the terms contained in the Settlement Agreement requested by the parties.

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 June 30, 2013 are 10.00% and 8.31%, respectively.  BSWC’s allowed return on equity, as of June 30, 2013 is 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, in total, 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, dropping consumption and small expense increases. These applications are currently under review at the MPUC, and a final decision is expected within nine months.

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.

10



2.
Pension and Other Post-Retirement Benefits

The following tables set forth the components of pension and other post-retirement benefit costs for the three and six months ended June 30, 2013 and 2012.

Pension Benefits
Components of Net Periodic Cost (in thousands):
 
Three Months
 
Six Months
Period ended June 30,
2013
 
2012
 
2013
 
2012
Service Cost
$
513

 
$
486

 
$
1,100

 
$
1,010

Interest Cost
651

 
640

 
1,306

 
1,285

Expected Return on Plan Assets
(727
)
 
(659
)
 
(1,473
)
 
(1,346
)
Amortization of:
 

 
 

 
 
 
 
Prior Service Cost
19

 
20

 
37

 
37

Net Loss
540

 
519

 
1,031

 
877

Net Periodic Benefit Cost
$
996

 
$
1,006

 
$
2,001

 
$
1,863


The Company expects to make a contribution to its defined benefit pension plan of approximately $2,490,000 in 2013 for the 2012 plan year, as allowed by the current funding status.

Post-Retirement Benefits Other Than Pension (PBOP)
Components of Net Periodic Cost (in thousands):
 
Three Months
 
Six Months
Period ended June 30,
2013
 
2012
 
2013
 
2012
Service Cost
$
176

 
$
118

 
$
337

 
$
275

Interest Cost
129

 
129

 
254

 
270

Expected Return on Plan Assets
(70
)
 
(67
)
 
(145
)
 
(135
)
Other
56

 
56

 
112

 
112

Amortization of:
 

 
 

 
 
 
 
Prior Service Cost
(202
)
 
(202
)
 
(403
)
 
(403
)
Recognized Net Loss
118

 
140

 
215

 
306

Net Periodic Benefit Cost
$
207

 
$
174

 
$
370

 
$
425



11


3.
Earnings per Share

Earnings per weighted average common share are calculated by dividing net income applicable to common stock by the weighted average number of shares of common stock outstanding during the respective periods as detailed below (diluted shares include the effect of unexercised stock options):
Three months ended June 30,
2013
 
2012
Common Shares Outstanding End of Period:
11,001,715

 
8,815,234

Weighted Average Shares Outstanding (Days Outstanding Basis):
 

 
 

Basic
10,818,883

 
8,667,440

Diluted
10,988,813

 
8,805,338

 
 
 
 
Basic Earnings per Share
$
0.40

 
$
0.48

Dilutive Effect of Unexercised Stock Options
(0.01
)
 
(0.01
)
Diluted Earnings per Share
$
0.39

 
$
0.47

 
 
 
 
Six Months ended June 30,
 
 
 
Weighted Average Shares Outstanding (Days Outstanding Basis):
 
 
 
Basic
10,811,100

 
8,659,176

Diluted
10,976,812

 
8,793,176

 
 
 
 
Basic Earnings per Share
$
0.64

 
$
0.70

Dilutive Effect of Unexercised Stock Options
(0.01
)
 
(0.01
)
Diluted Earnings per Share
$
0.63

 
$
0.69


Total unrecognized compensation expense for all stock awards was approximately $1.3 million as of June 30, 2013 and will be recognized over a weighted average period of 1.2 years.

4.
New Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board ("FASB") issued updated accounting guidance to improve the reporting of reclassifications out of accumulated other comprehensive income (“AOCI”). The update requires an entity to present information about the amounts reclassified from AOCI in their financial statements in either a single note or parenthetically on the face of the financial statements. The updated guidance is effective prospectively for reporting periods beginning after December 15, 2012. The Company adopted the provisions of the updated guidance for its quarterly reporting period beginning January 1, 2013. The adoption of the revised guidance had no impact on the Company's consolidated results of operations or consolidated financial position, but the Company did add additional disclosures, see Note 5.


12

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

5.
Accumulated Other Comprehensive Income (Loss)

The changes in Accumulated Other Comprehensive Income/(Loss) ("AOCI") by component, net of tax, for the three and six months ended June 30, 2013 is as follows (in thousands):
Three Months Ended June 30, 2013
 
Interest Rate Swap
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
(41
)
 
$
117

 
$
(1,381
)
 
$
(1,305
)
Other Comprehensive Income Before Reclassification
 

 
4

 

 
4

Amounts Reclassified from AOCI
 
1

 
1

 
92

 
94

Net current-period Other Comprehensive Income (Loss)
 
1

 
5

 
92

 
98

Ending Balance
 
$
(40
)
 
$
122

 
$
(1,289
)
 
$
(1,207
)
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2013
 
Interest Rate Swap
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
(41
)
 
$
69

 
$
(1,356
)
 
$
(1,328
)
Other Comprehensive Income Before Reclassification
 

 
41

 

 
41

Amounts Reclassified from AOCI
 
1

 
12

 
67

 
80

Net current-period Other Comprehensive Income (Loss)
 
1

 
53

 
67

 
121

Ending Balance
 
$
(40
)
 
$
122

 
$
(1,289
)
 
$
(1,207
)
 
 
 
 
 
 
 
 
 
(a) All amounts shown are net of tax. Amounts in parentheses indicate loss.

The following table sets forth the amounts reclassified from AOCI by component and the affected line item on the Condensed Consolidated Statement of Income for the three and six months ended June 30, 2013 (in thousands):
Details about Other AOCI Components
 
Amounts Reclassified from AOCI Three Months Ended June 30, 2013(a)
 
Amounts Reclassified from AOCI Six Months Ended June 30, 2013(a)
 
Affected Line Items on Income Statement
Amortization of Cash Flow Hedging Instrument
 
1

 
1

 
Other Income
Tax expense
 

 

 
Other Income
 
 
1

 
1

 
 
 
 
 
 
 
 
 
Realized Gains on Investments
 
3

 
21

 
Other Income
Tax expense
 
(2
)
 
(9
)
 
Other Income
 
 
1

 
12

 
 
 
 
 
 
 
 
 
Amortization of Recognized Net Loss from Defined Benefit Items
 
120

 
112

 
Other Income (b)
Tax expense
 
(28
)
 
(45
)
 
Other Income
 
 
92

 
67

 
 
 
 
 
 
 
 
 
Total Reclassifications for the period, net of tax
 
94

 
80

 
 
 
 
 
 
 
 
 
(a) Amounts in parentheses indicate loss.
(b) Included in computation of net periodic pension cost (see Note 2 for additional details).


13

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

6.
Long-Term Debt

Long-Term Debt at June 30, 2013 and December 31, 2012 consisted of the following (in thousands):
 
2013
 
2012
Connecticut Water Service, Inc.:
 
 
 
4.09%
 
Term Loan Note
$
16,883

 
$
17,337

The Connecticut Water Company:
 
 
 
Var.
 
2004 Series Variable Rate, Due 2029
12,500

 
12,500

Var.
 
2004 Series A, Due 2028
5,000

 
5,000

Var.
 
2004 Series B, Due 2028
4,550

 
4,550

5.00%
 
2007 A Series, Due 2037

 
14,550

5.10%
 
2009 A Series, Due 2039
19,950

 
19,950

5.00%
 
2011 A Series, Due 2021
23,699

 
23,797

3.16%
 
CoBank Note Payable, Due 2020
8,000

 
8,000

3.51%
 
CoBank Note Payable, Due 2022
14,795

 
14,795

4.29%
 
CoBank Note Payable, Due 2028
17,020

 
17,020

4.72%
 
CoBank Note Payable, Due 2032
14,795

 
14,795

4.75%
 
CoBank Note Payable, Due 2033
14,550

 

Total The Connecticut Water Company
134,859

 
134,957

The Maine Water Company:
 
 
 
8.95%
 
1994 Series G, Due 2024
9,000

 
9,000

2.68%
 
1999 Series J, Due 2019
474

 
524

0.00%
 
2001 Series K, Due 2031
739

 
780

2.58%
 
2002 Series L, Due 2022
90

 
98

1.53%
 
2003 Series M, Due 2023
401

 
421

1.73%
 
2004 Series N, Due 2024
471

 
471

0.00%
 
2004 Series O, Due 2034
140

 
147

1.76%
 
2006 Series P, Due 2026
451

 
471

1.57%
 
2009 Series R, Due 2029
242

 
247

0.00%
 
2009 Series S, Due 2029
740

 
762

0.00%
 
2009 Series T, Due 2029
2,075

 
2,137

0.00%
 
2012 Series U, Due 2042
171

 
177

1.00%
 
2013 Series V, Due 2033
1,410

 

2.52%
 
CoBank Note Payable, Due 2017
1,965

 
1,965

Total The Maine Water Company
18,369

 
17,200

The Biddeford & Saco Water Company
 
 
 
6.45%
 
Series M, Due 2014
2,700

 
2,700

7.72%
 
Series L, Due 2018
2,250

 
2,250

2.40%
 
Series N, Due 2022
1,297

 
1,297

1.86%
 
Series O, Due 2025
862

 
862

2.23%
 
Series P, Due 2028
1,354

 
1,354

Various
 
Various Capital Leases
103

 
126

Total The Biddeford & Saco Water Company
8,566

 
8,589

Add:  Acquisition Fair Value Adjustment
1,442

 
1,696

Less:  Current Portion
(1,388
)
 
(1,304
)
Total Long-Term Debt
$
178,731

 
$
178,475


As of June 30, 2013, the Company and its subsidiaries will make principal payments of approximately $1,388,000 over the next twelve months.


14

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

In December 2011, Connecticut Water borrowed $22.05 million through the issuance of Water Facilities Revenue Bonds by the Connecticut Innovations, Inc. (formerly known as the Connecticut Development Authority).  Connecticut Water received approximately $24,000,000 in cash in exchange for the issuance of bonds with an aggregate principal amount of $22,050,000 with a maturity date of December 20, 2021 and a 5% coupon.  Connecticut Water recorded a bond premium in connection with this transaction and is amortizing that premium over the life of the bond.  The proceeds from the sale of the bonds are being used to finance construction and installation of various capital improvements to Connecticut Water’s existing water system.

There are no mandatory sinking fund payments required on Connecticut Water’s outstanding Water Facilities Revenue Bonds.  However, certain fixed rate Unsecured Water Facilities Revenue Refinancing Bonds provide for an estate redemption right whereby the estate of deceased bondholders or surviving joint owners may submit bonds to the Trustee for redemption at par, subject to a $25,000 per individual holder and a 3% annual aggregate limitation.

On January 1, 2012, the Company and CoBank, ACB ("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 “2012 Term Loan Notes”).  Under the terms of the Amendment and the 2012 Term Loan Notes, 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. The second Term Note was repaid in December 2012 with a portion of the proceeds from the Company's equity issuance.

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.

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 proceeds of the Loan will be used by Maine Water to fund various water facilities projects.

Financial Covenants – The Company and its subsidiaries are required to comply with certain covenants in connection with various long term loan agreements.  The most restrictive of these covenants is to maintain a consolidated debt to capitalization ratio of not more than 60%. The Company and its subsidiaries were in compliance with all covenants at June 30, 2013.


15

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

7.
Fair Value Disclosures

FASB Accounting Standards Codification ("ASC") 820, Fair Value Measurements and Disclosures (“FASB ASC 820”) provides enhanced guidance for using fair value to measure assets and liabilities and expands disclosure with respect to fair value measurements.

FASB ASC 820 establishes a fair value hierarchy that distinguishes between assumptions based on market data (observable inputs) and the Company’s assumptions (unobservable inputs).  The hierarchy consists of three broad levels, as follows:

Level 1 – Quoted market prices in active markets for identical assets or liabilities.
Level 2 – Inputs other than Level 1 that are either directly or indirectly observable.
Level 3 – Unobservable inputs developed using the Company’s estimates and assumptions, which reflect those that the Company believes market participants would use.

The following table summarizes our financial instruments measured at fair value on a recurring basis within the fair value hierarchy as of June 30, 2013 (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Asset Type:
 
 
 
 
 
 
 
Company Owned Life Insurance
$

 
$
2,619

 
$

 
$
2,619

Money Market Fund
132

 

 

 
132

Mutual Funds:
 

 
 

 
 

 
 

Equity Funds (1)
965

 

 

 
965

Total
$
1,097

 
$
2,619

 
$

 
$
3,716


The following table summarizes our financial instruments measured at fair value on a recurring basis within the fair value hierarchy as of December 31, 2012 (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Asset Type:
 
 
 
 
 
 
 
Company Owned Life Insurance
$

 
$
2,538

 
$

 
$
2,538

Money Market Fund
28

 

 

 
28

Mutual Funds:
 

 
 

 
 

 
 

Equity Funds (1)
1,046

 

 

 
1,046

Total
$
1,074

 
$
2,538

 
$

 
$
3,612

(1)
Mutual funds consisting primarily of equity securities and are presented on the Other Property and Investments line item of the Company's Condensed Consolidated Balance Sheets.

The fair value of Company Owned Life Insurance is based on the cash surrender value of the contracts. These contracts are based principally on a referenced pool of investment funds that actively redeem shares and are observable and measurable and are presented on the Other Property and Investments line item of the Company's Condensed Consolidated Balance Sheets.

The following methods and assumptions were used to estimate the fair value of each of the following financial instruments, which are not recorded at fair value on the financial statements.

Cash and cash equivalents – Cash equivalents consist of highly liquid instruments with original maturities at the time of purchase of three months or less.  The carrying amount approximates fair value.  Under the fair value hierarchy the fair value of cash and cash equivalents is classified as a Level 1 measurement.

Restricted Cash – As part of the Connecticut Water’s December 2011 bond offering, the Company recorded unused proceeds from this bond issuance as restricted cash as the funds can only be used for certain capital expenditures.  The Company expects to use the remainder of the proceeds during 2013, as the approved capital expenditures are completed.  The carrying amount approximates fair value.  Under the fair value hierarchy the fair value of restricted cash is classified as a Level 1 measurement.

Long-Term Debt – The fair value of the Company's fixed rate long-term debt is based upon borrowing rates currently available to the Company.  As of June 30, 2013 and December 31, 2012, the estimated fair value of the Company's long-term debt was

16

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

$183,000,000 and $194,900,000, respectively, as compared to the carrying amounts of $178,731,000 and $178,475,000, respectively. The estimated fair value of long term debt was calculated using a discounted cash flow model that uses comparable interest rates and yield curve data based on the A-rated MMD (Municipal Market Data) Index which is the benchmark of current municipal bond yields. Under the fair value hierarchy, the fair value of long term debt is classified as a Level 2 measurement.

The fair values shown above have been reported to meet the disclosure requirements of accounting principles generally accepted in the United States and do not purport to represent the amounts at which those obligations would be settled.

8.
Segment Reporting

The Company operates principally in three business segments: Water Activities, Real Estate Transactions, and Services and Rentals.  Results of operations for the three and six months ended June 30, 2013 include the results of BSWC.  Financial data for the segments is as follows (in thousands):
Three Months Ended June 30, 2013
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense
 
Net Income
Water Activities
 
$
22,854

 
$
6,379

 
$
2,445

 
$
3,934

Real Estate Transactions
 

 

 

 

Services and Rentals
 
1,477

 
634

 
258

 
376

Total
 
$
24,331

 
$
7,013

 
$
2,703

 
$
4,310

Three Months Ended June 30, 2012
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense
 
Net Income
Water Activities
 
$
21,672

 
$
4,929

 
$
2,081

 
$
2,848

Real Estate Transactions
 
1,450

 
1,331

 
349

 
982

Services and Rentals
 
1,366

 
562

 
229

 
333

Total
 
$
24,488

 
$
6,822

 
$
2,659

 
$
4,163

Six Months Ended June 30, 2013
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense
 
Net Income
Water Activities
 
$
42,982


$
9,929

 
$
3,768

 
$
6,161

Real Estate Transactions
 



 

 

Services and Rentals
 
2,866


1,287

 
525

 
762

Total
 
$
45,848

 
$
11,216

 
$
4,293

 
$
6,923

Six Months Ended June 30, 2012
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense
 
Net Income
Water Activities
 
$
40,561

 
$
7,414

 
$
3,006

 
$
4,408

Real Estate Transactions
 
1,450

 
1,331

 
349

 
982

Services and Rentals
 
2,701

 
1,153

 
470

 
683

Total
 
$
44,712

 
$
9,898

 
$
3,825

 
$
6,073


The revenues shown in Water Activities above consisted of revenues from water customers of $22,545,000 and $21,348,000 for the three months ended June 30, 2013 and 2012, respectively.  Additionally, there were revenues associated with utility plant leased to others of $309,000 and $324,000 for the three months ended June 30, 2013 and 2012, respectively. The revenues shown in Water Activities above consisted of revenues from water customers of $42,274,000 and $39,888,000 for the six months ended June 30, 2013 and 2012, respectively.  Additionally, there were revenues associated with utility plant leased to others of $708,000 and $673,000 for the six months ended June 30, 2013 and 2012, respectively.

The Company owns various small, discrete parcels of land that are no longer required for water supply purposes.  From time to time, the Company may sell or donate these parcels, depending on various factors, including the current market for land, the

17

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

amount of tax benefits received for donations and the Company’s ability to use any benefits received from donations.  During the six months ended June 30, 2013, the Company did not engage in any such transactions. During the six months ended June 30, 2012, the Company completed the previously announced sale of a parcel of land in the Town of Plymouth, CT.

Assets by segment (in thousands):
 
June 30,
2013
 
December 31,
2012
Total Plant and Other Investments:
 
 
 
Water Activities
$
461,330

 
$
453,625

Non-Water
801

 
680

 
462,131

 
454,305

Other Assets:
 
 
 
Water Activities
120,468

 
118,020

Non-Water
3,497

 
6,650

 
123,965

 
124,670

Total Assets
$
586,096

 
$
578,975


9.
Income Taxes

FASB ASC 740 Income Taxes (“FASB ASC 740”) addresses the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FASB ASC 740, the Company must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. On June 11, 2013, the Company was notified by the Connecticut Department of Revenue Services that its state tax filings for the years 2009 through 2011 would be reviewed. The Company is also aware that certain of its peers have been challenged on certain tax credits associated with fixed capital investment credits and believes that this may be a focus of the State's review. While the Company firmly believes that all fixed capital investment credits are appropriate and conservatively measured, the Company believes, based on recent activities by taxing authorities, that it is more likely than not that some portion of the Company's fixed capital investment credits claimed in prior years may be challenged and ultimately disallowed. Therefore, as required by FASB ASC 740, during the three months ended June, 30, 2013, the Company recorded a reserve of $1.4 million, or 50% of the credits recorded that would be subject to disallowance.

From time to time, the Company may be assessed interest and penalties by taxing authorities.  In those cases, the charges would appear on the Other line item within the Other Income (Deductions), Net of Taxes section of the Company's Condensed Consolidated Statements of Income.  There were no such charges for the six months ended June 30, 2013 and 2012.  Additionally, there were no accruals relating to interest or penalties as of June 30, 2013 and December 31, 2012.  The Company remains subject to examination by federal authorities for the 2010 and 2011 tax years.

The Company is currently engaged in an analysis to determine the amount of expenditures related to tangible property that will be reflected on its 2012 Federal Tax Return to be filed in September 2013, creating a change in accounting method for tax purposes. As a result, in the second quarter of 2013, the Company has estimated the portion of its infrastructure investment that will qualify as a repair deduction for 2013 and has reflected that deduction in its effective tax rate at 50% of the expected $15 million of infrastructure improvement. Consistent with other differences between book and tax expenditures, the Company is required to flow-through any timing differences not required by the Internal Revenue Service to be normalized.

The Company’s effective income tax rate for the first six months of 2013 and 2012 was 38.3% and 38.7%, respectively.  The Company's effective tax rate excluding the fixed capital investment credit discussed above was 24.3% for the six months ended June 30, 2013. The statutory income tax rates during each period was 41%.  In determining its annual estimated effective tax rate for interim periods, the Company reflects its estimated permanent and flow-through tax differences for the taxable year.


18

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

10.
Lines of Credit

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.  On June 30, 2013, the Company allowed BSWC's $2.25 million line of credit to expire. As of June 30, 2013, the total lines of credit available to the Company was $35.0 million.  Interim Bank Loans Payable at June 30, 2013 and December 31, 2012 was approximately $0.1 million and $1.7 million, respectively, and represents the outstanding aggregate balances on these lines of credit. As discussed in Part I, Item 2 below, 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 June 30, 2013, the Company had $34.9 million in unused lines of credit.  Interest expense charged on interim bank loans will fluctuate based on market interest rates.

11.
Acquisitions

Effective December 10, 2012, the Company completed the acquisition of the Biddeford & Saco Water Company ("BSWC"). This acquisition further expanded the Company's footprint into another New England state, providing the Company with diversity with respect to weather and regulatory climate and ratemaking. Shareholders of BSWC common stock exchanged all outstanding shares of BSWC for 380,254 shares of Connecticut Water Service, Inc. in a transaction valued at approximately $12.0 million, based on the closing price of the Company's common stock on the acquisition date. BSWC is a public water utility regulated by the Maine Public Utility Commission ("MPUC") that serves approximately 15,000 customers in 4 communities in the State of Maine. The Company is accounting for the acquisition in accordance with FASB ASC 805 Business Combinations ("FASB ASC 805").

The estimated fair values of assets acquired and liabilities assumed, including BSWC's outstanding long-term debt, are based upon the information that was available as of the acquisition dates, which management believes provides a reasonable basis for the estimated values. The fair values of long term-debt were based on similar marketable instruments. Management is analyzing additional data necessary to finalize these fair values, which are subject to change. While such changes could be significant, management does not expect them to be, based upon the information provided to date. The valuation, and thus the purchase price allocation, is expected to be completed as soon as practicable but no later than one year from the acquisition date.

The Company incurred pre-tax acquisition and closing related expenses of approximately $544,000 during the year ended December 31, 2012 to acquire BSWC which is recorded on the "Other" line item of the "Other Income (Deductions), Net of Taxes" section of the Consolidated Statements of Income.

The following table summarizes the estimated fair value of the BSWC assets acquired on December 10, 2012, the date of the acquisition (in thousands):
Net Utility Plant
$
19,411

Cash and Cash Equivalents
14

Accounts Receivable, net
628

Prepayments and Other Current Assets
545

Goodwill
7,708

Deferred Charges and Other Costs
554

Total Assets Acquired
$
28,860

 
 

Long-Term Debt, including current portion
$
9,263

Accounts Payable and Accrued Expenses
254

Other Current Liabilities
1,076

Advances for Construction
714

Contributions in Aid of Construction
2,568

Deferred Federal and State Income Taxes
1,668

Other Long-Term Liabilities
1,305

Total Liabilities Assumed
$
16,848

 
 

Net Assets Acquired
$
12,012


19

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


The estimated fair values of the assets acquired and the liabilities assumed were determined based on the accounting guidance for fair value measurement under GAAP, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value analysis assumes the highest and best use of the assets by market participants. For BSWC, the allocation of the purchase price includes an adjustment to fair value related to BSWC's long-term debt and any associated deferred taxes. The excess of the purchase price paid over the estimated fair value of the assets acquired and the liabilities assumed was recognized as goodwill in the Water Activities Segment, none of which is deductible for tax purposes.

Goodwill is calculated as the excess of the purchase price over the net assets acquired and the contributing factors to the amount recorded include expected future cash flows, potential operational synergies, the utilization of technology and cost savings opportunities in the delivery of certain shared administrative and other services.

The following unaudited pro forma summary for the three and six months ended June 30, 2012 presents information as if BSWC had been acquired on January 1, 2012 and assumes that there were no other changes in our operations.  The following pro forma information does not necessarily reflect the actual results that would have occurred had the Company operated the business since January 1, 2012, nor is it necessarily indicative of the future results of operations of the combined companies (in thousands):
 
Three Months Ended
 
Six Months Ended
Operating Revenues
$
22,465

 
$
41,955

Other Water Activities Revenues
324

 
673

Real Estate Revenues
1,450

 
1,450

Service and Rentals Revenues
1,394

 
2,767

Total Revenues
$
25,633

 
$
46,845

 
 

 
 
Net Income
$
4,235

 
$
6,135

 
 

 
 
Basic Earnings per Average Share Outstanding
$
0.49

 
$
0.71

Diluted Earnings per Average Share Outstanding
$
0.48

 
$
0.70


The following table summarizes the results of BSWC for the three and six months ended June 30, 2013, and is included in the Condensed Consolidated Statement of Income for the period (in thousands):
 
Three Months Ended
 
Six Months Ended
Operating Revenues
$
1,110

 
$
2,039

Other Water Activities Revenues

 

Real Estate Revenues

 

Service and Rentals Revenues
9

 
63

Total Revenues
$
1,119

 
$
2,102

 
 

 
 
Net Income (Loss)
$
52

 
$
(99
)
 
 

 
 
Basic Income (Loss) per Average Share Outstanding
$

 
$
(0.01
)

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.


20


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 for more information.

UCONN Proposal

Beginning in June 2011, the University of Connecticut, in partnership with the Town of Mansfield, initiated a process to identify and implement actions to secure a long-term water supply source for the University and the Town.  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. The Connecticut Water submission for this project was made as part of the Environmental Impact Evaluation (EIE) process.  As detailed in its proposal, Connecticut Water proposes to bring up to 2 million gallons of water a day approximately 5 miles from its water system near Tolland to Mansfield to solve the University campus and the Town's water shortage.   Connecticut Water has been advised by the University that, on August 7, 2013, the Board of Trustees of the University voted to approve Connecticut Water's proposal.  With this approval vote, the next steps for the project include: a comprehensive review of the EIE and Connecticut Water's proposed solution by the State's Office of Policy and Management; contract negotiations between Connecticut Water,  the University and the Town of Mansfield, and application for necessary permits to be issued by the Connecticut Department of Energy and Environmental Protection.

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

21


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 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. Connecticut Water expects the PURA to issue a decision on the WICA application during the third quarter of 2013 with the new rates becoming effective on October 1, 2013.

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 by PURA 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 will treat 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 will allow Connecticut Water to record a favorable “catch up adjustment” on the Company's consolidated 2012 federal tax return to be filed in September 2013. The Company anticipates that it will be entitled to receive a significant tax refund 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 (although the total amount of these deductions will not be known until the Company's 2012 tax return is complete, the Company currently estimates the amount of the deduction will be approximately $10 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 (expected to be approximately 7.9% effective as of October 1, 2013) 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 are also requesting 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 for later crediting to or collection from

22


customers of the amount by which actual revenues deviate from the revenues allowed Connecticut Water's in most recent general rate proceeding.

The Agreement provides that, if the PURA does not fully approve the Agreement in its entirety, it shall be deemed withdrawn. Accordingly, the Agreement has no operative effect unless and until it is approved by the PURA.

The parties to the Settlement Agreement have asked the PURA to issue a decision as soon as possible but not later than August 31, 2013; however, the Company is not able to predict with certainty the ultimate timing of the PURA's final action on the Settlement Agreement. No assurance can be given that the PURA will approve the Agreement and permit some or all of the terms contained in the Settlement Agreement requested by the parties.

Based on Connecticut Water's allowed revenues, as approved by PURA during our 2010 general rate case and including WICA surcharges, the Company believes that it would have recorded approximately $36.3 million in revenues in the six months ended June 30, 2013, which is approximately $1.5 million additional revenue compared to the $34.8 million in revenue recorded by Connecticut Water. The additional revenue would have generated approximately $0.08 in additional earnings per share in the six months ended June 30, 2013. Based on historical analysis, the Company believes that approximately 52% of Connecticut Water's annual revenue will be earned in the final six 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 June 30, 2013 are 10.00% and 8.31%, respectively.  BSWC’s allowed return on equity, as of June 30, 2013 is 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, in total, 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, dropping consumption and small expense increases. These applications are currently under review at the MPUC, and a final decision is expected within nine months.

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.


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 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.

23



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.

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 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, 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.  On June 30, 2013, the Company allowed BSWC's $2.25 million line of credit to expire. As of June 30, 2013, the total lines of credit available to the Company was $35.00 million.  Interim Bank Loans Payable at June 30, 2013 and December 31, 2012 was approximately $0.1 million and $1.7 million, respectively, and represents the outstanding aggregate balances on these lines of credit. As discussed in Part I, Item 2 below, 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 June 30, 2013, the Company had $34.9 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

24


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.  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. 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 six months ended June 30, 2013 and 2012, plan participants invested $798,000 and $703,000, 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 six months ended June 30, 2013, no stock options were exercised.  During the six months ended June 30, 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

25


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.

2013 Construction Budget

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 June 30
Net Income for the three months ended June 30, 2013 increased from the same period in the prior year by $147,000 to $4,310,000. Due to the issuance of approximately 2.1 million shares of common stock during 2012, earnings per basic average common share decreased by $0.08 to $0.40 during the three months ended June 30, 2013.

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

Business Segment
 
June 30, 2013
 
June 30, 2012
 
Increase/(Decrease)
Water Activities
 
$
3,934

 
$
2,848

 
$
1,086

Real Estate Transactions
 

 
982

 
(982
)
Services and Rentals
 
376

 
333

 
43

Total
 
$
4,310

 
$
4,163

 
$
147


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 $1,197,000, or 5.6%, to $22,545,000 for the three months ended June 30, 2013 when compared to the same period in 2012.  The primary reason for the increase in revenues was the acquisition of BSWC, which contributed $1,110,000 in additional revenue during the period.  Excluding BSWC, the Company saw an increase in revenue from water customers of $87,000, or approximately 0.4% during the three months ended June 30, 2013.  The primary driver for the increase in revenue in 2013 was the increased rates in 2013 associated with Connecticut Water's recurring WICA surcharge.


26


Operation and Maintenance Expense

Operation and Maintenance (“O&M”) expense increased by $281,000, or 2.8%, for the three months ended June 30, 2013 when compared to the same period of 2012 primarily due to the acquisition of BSWC, which contributed $764,000 of incremental O&M expense.  The following table presents the components of O&M expense both including and excluding BSWC (in thousands):

Expense Components
 
Actual June 30, 2013 O&M
 
Actual June 30, 2012 O&M
 
Actual Increase / (Decrease)
 
BSWC June 30, 2013 O&M
 
Adjusted Increase / (Decrease)
Maintenance
 
$
672

 
$
551

 
$
121

 
$
43

 
$
78

Investor relations
 
287

 
211

 
76

 

 
76

Outside services
 
595

 
419

 
176

 
102

 
74

Purchased water
 
421

 
348

 
73

 

 
73

Customer costs
 
293

 
207

 
86

 
40

 
46

Post-retirement medical
 
208

 
173

 
35

 

 
35

Other benefits
 
139

 
199

 
(60
)
 

 
(60
)
Medical
 
813

 
755

 
58

 
176

 
(118
)
Water treatment (including chemicals)
 
674

 
727

 
(53
)
 
71

 
(124
)
Utility costs
 
786

 
866

 
(80
)
 
50

 
(130
)
Payroll
 
3,512

 
3,427

 
85

 
225

 
(140
)
Other
 
1,957

 
2,193

 
(236
)
 
57

 
(293
)
Total
 
$
10,357

 
$
10,076

 
$
281

 
$
764

 
$
(483
)

The decrease in O&M expenses excluding the incremental expense as a result of the acquisition of BSWC, was approximately $483,000, or approximately 4.8%, in the second 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 June 30, 2013 when compared to June 30, 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 designed to help reduce the costs of water infrastructure projects in future periods;
Utility costs decreased primarily due to lower electric costs driven by energy audits conducted at various sites and reduced rates through an energy auction;
Water treatment costs decreased primarily due to a reduction in the costs to dispose of waste generated at treatment plants; and
Medical costs decreased in the second quarter of 2013 when compared to the same period in 2012 due primarily to a reduction in claims filed by plan participants.

The decreases described above were partially offset by the following increases to O&M expense:
Costs associated with Investor relations increased in 2013 primarily due to higher costs associated with the preparation and distribution of the Company's Proxy Statement for the Annual Meeting of Shareholders;
Outside services expense increased primarily due to an increase in consulting fees related to the organizational design portion of the Company's ongoing procurement project; and
Purchased water costs increased due to an increase in water being bought from neighboring utilities, particularly in Connecticut Water's Northern Region, partially offset by a decrease in purchased water costs at Maine Water.

The Company saw an approximate 8.7% increase in its Depreciation expense from the three months ended June 30, 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 1.7% for the three months ended June 30, 2013. The remainder of the increase in Depreciation expense was due to higher Utility Plant in Service as of June 30, 2013 compared to June 30, 2012.

Income Tax expense associated with Water Activities, which includes the Other line in the Other Income (Deductions), Net of Taxes section of the Condensed Consolidated Statements of Income, increased by $364,000 in the second 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

27


increased by $319,000. While the Company's effective tax rate was flat in the three months ended June 30, 2013 and 2012, the reserve made for the fixed capital credits and the expected impact of the IRS repair tax deduction largely offset each other.

Other Income (Deductions), Net of Taxes decreased for the three months ended June 30, 2013 by $755,000. The primary driver of this decrease was the completion of a land sale to the Town of Plymouth, CT in the second quarter of 2012. Excluding the land sale, Other Income (Deductions), Net of Taxes increased by $227,000, primarily due to merger costs incurred during 2012 related to the acquisitions of Maine Water and BSWC.

Total Interest and Debt Expense decreased by $663,000 in three months ended June 30, 2013 when compared to the same period in 2012 due to an increase in the patronage income 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 approximately $14.6 million in long-term debt in the first quarter of 2013 and the repayment of approximately $18.0 million in debt used to acquire Maine Water.

Six months ended June 30
Net Income for the six months ended June 30, 2013 increased from the same period in the prior year by $850,000 to $6,923,000. Due to the issuance of approximately 2.1 million shares of common stock during 2012, earnings per basic average common share decreased by $0.06 to $0.64 during the six months ended June 30, 2013.

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

Business Segment
 
June 30, 2013
 
June 30, 2012
 
Increase/(Decrease)
Water Activities
 
$
6,161

 
$
4,408

 
$
1,753

Real Estate Transactions
 

 
982

 
(982
)
Services and Rentals
 
762

 
683

 
79

Total
 
$
6,923

 
$
6,073

 
$
850


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 $2,386,000, or 6.0%, to $42,274,000 for the six months ended June 30, 2013 when compared to the same period in 2012.  The primary reason for the increase in revenues was the acquisition of BSWC, which contributed $2,039,000 in additional revenue during the period.  Excluding BSWC, the Company saw an increase in revenue from water customers of $347,000, or approximately 0.9% during the six months ended June 30, 2013.  The primary driver for the increase in revenue in 2013 was the increased rates in 2013 associated with Connecticut Water's recurring WICA surcharge.


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Operation and Maintenance Expense

Operation and Maintenance (“O&M”) expense increased by $1,024,000, or 5.2%, for the six months ended June 30, 2013 when compared to the same period of 2012 primarily due to the acquisition of BSWC, which contributed $1,598,000 of incremental O&M expense.  The following table presents the components of O&M expense both including and excluding BSWC (in thousands):

Expense Components
 
Actual June 30, 2013 O&M
 
Actual June 30, 2012 O&M
 
Actual Increase / (Decrease)
 
BSWC June 30, 2013 O&M
 
Adjusted Increase / (Decrease)
Customer
 
$
729

 
$
433

 
$
296

 
$
87

 
$
209

Outside services
 
1,159

 
750

 
409

 
203

 
206

Maintenance
 
1,293

 
1,045

 
248

 
103

 
145

Pension
 
1,985

 
1,862

 
123

 

 
123

Investor relations
 
461

 
368

 
93

 

 
93

Purchased water
 
690

 
628

 
62

 

 
62

Post retirement medical
 
371

 
426

 
(55
)
 

 
(55
)
Utility costs
 
1,885

 
1,846

 
39

 
113

 
(74
)
Other benefits
 
449

 
572

 
(123
)
 

 
(123
)
Amston Lake water quality monitoring costs (non-labor)
 

 
135

 
(135
)
 

 
(135
)
Water treatment (including chemicals)
 
1,285

 
1,357

 
(72
)
 
134

 
(206
)
Payroll
 
7,037

 
6,749

 
288

 
532

 
(244
)
Medical
 
1,445

 
1,367

 
78

 
324

 
(246
)
Other
 
1,946

 
2,173

 
(227
)
 
102

 
(329
)
Total
 
$
20,735

 
$
19,711

 
$
1,024

 
$
1,598

 
$
(574
)

The decrease in O&M expenses, excluding the incremental expense as a result of the acquisition of BSWC, was approximately $574,000, or approximately 2.9%, in the six months ended June 30, 2013 when compared to the same period in 2012.  The changes in individual items, excluding the impact of BSWC, are described below:
The largest driver in the decrease in Other is due to the treatment of fluctuations in the Company's stock price related to certain stock awards of senior management;
Medical costs decreased in the first six months of 2013 when compared to the same period in 2012 due primarily to a reduction in claims filed by plan participants;
Payroll costs decreased primarily due to a decrease in the number employees at June 30, 2013 when compared to June 30, 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 designed to help reduce the costs of water infrastructure projects in future periods;
Water treatment costs decreased primarily due to a reduction in the costs to dispose of waste generated at treatment plants; and
Early in the first six months 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;
Outside services expense increased primarily due to an increase in consulting fees related to the organizational design portion of the Company's ongoing procurement project; and
The increase in Pension costs was attributable primarily to a decrease in the discount rate used in determining net periodic benefit costs in 2013.

The Company saw an approximate 11.0% increase in its Depreciation expense from the six months ended June 30, 2013 compared to the same period in 2012.  The primary driver of this increase was approximately $336,000 in Depreciation expense attributable

29


to BSWC.  Excluding the impact of BSWC, the Company's depreciation expense increased by approximately 4.0% for the six months ended June 30, 2013. The remainder of the increase in Depreciation expense was due to higher Utility Plant in Service as of June 30, 2013 compared to June 30, 2012.

Income Tax expense associated with Water Activities, which includes the Other line in the Other Income (Deductions), Net of Taxes section of the Condensed Consolidated Statements of Income, increased by $762,000 in the six months ended June 30, 2013 when compared to the same period in 2012 due to higher pre-tax net income. Excluding the impact of BSWC, which had a tax benefit for the six months ended June 30, 2013, Income Tax expense increased by $588,000. While the Company's effective tax rate was flat in the three months ended June 30, 2013 and 2012, the reserve made for the fixed capital credits and the expected impact of the IRS repair tax deduction largely offset each other.

Other Income (Deductions), Net of Taxes decreased for the six months ended June 30, 2013 by $639,000. The primary driver of this increase was the completion of a land sale to the Town of Plymouth, CT in the second quarter of 2012. Excluding the land sale, Other Income (Deductions), Net of Taxes increased by $343,000, driven primarily by a reduction in acquisition costs in 2013 and an increase in patronage income from one of our banking partners, and higher earnings in our unregulated company, New England Water Utility Services.

Total Interest and Debt Expense decreased by $1,412,000 in the six months ended June 30, 2013 when compared to the same period in 2012 due to an increase in the patronage income 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 approximately $14.6 million in long-term debt in the first quarter of 2013 and the repayment of approximately $18.0 million in debt used to acquire Maine Water.

Commitments and Contingencies

On June 11, 2013, the Company was notified by the Connecticut Department of Revenue Services that its state tax filings for the years 2009 through 2011 would be reviewed. See Note 9 for further details.

There were no material changes under this subheading to any of the other items previously disclosed by the Company in its Annual Report on Form 10-K for the period year December 31, 2012.

Forward-Looking Information

Certain statements made in this Quarterly Report on Form 10-Q, (“10-Q”) are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”) that are made based upon, among other things, our current assumptions, expectations and beliefs concerning future developments and their potential effect on us.  These forward-looking statements involve risks, uncertainties and other factors, many of which are outside our control, which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements.  In some cases you can identify forward-looking statements where statements are preceded by, followed by or include the words “believes,” “expects,” “anticipates,” “plans,” “future,” “potential,” “probably,” “predictions,” “continue” or the negative of such terms or similar expressions.  Forward-looking sta