10-Q 1 ctws10qq32013.htm 10-Q CTWS 10Q Q3 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 SEPTEMBER 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
11,018,161
Number of shares of common stock outstanding, October 31, 2013
(Includes 172,519 common stock equivalent shares awarded under the Performance Stock Programs) 



CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
 
Financial Report
September 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
 
September 30, 2013
 
December 31, 2012
Utility Plant
 
$
627,503

 
$
611,787

Construction Work in Progress
 
11,946

 
7,734

 
 
639,449

 
619,521

Accumulated Provision for Depreciation
 
(177,639
)
 
(171,610
)
Net Utility Plant
 
461,810

 
447,911

Other Property and Investments
 
7,135

 
6,394

Cash and Cash Equivalents
 
1,588

 
13,150

Accounts Receivable (Less Allowance, 2013 - $1,036; 2012 - $1,058)
 
14,306

 
11,526

Accrued Unbilled Revenues
 
8,708

 
7,233

Materials and Supplies, at Average Cost
 
2,021

 
1,629

Prepaid Income Taxes - Refund Receivable
 
13,813

 
347

Prepayments and Other Current Assets
 
6,785

 
2,477

Total Current Assets
 
47,221

 
36,362

Restricted Cash
 
9,938

 
9,820

Unamortized Debt Issuance Expense
 
6,979

 
7,411

Unrecovered Income Taxes - Regulatory Asset
 
41,870

 
9,871

Pension Benefits - Regulatory Asset
 
16,716

 
18,319

Post-Retirement Benefits Other Than Pension - Regulatory Asset
 
3,134

 
3,022

Goodwill
 
31,685

 
31,685

Deferred Charges and Other Costs
 
9,114

 
8,180

Total Regulatory and Other Long-Term Assets
 
119,436

 
88,308

Total Assets
 
$
635,602

 
$
578,975

CAPITALIZATION AND LIABILITIES
 
 

 
 

Common Stockholders' Equity:
 
 

 
 

Common Stock Without Par Value: Authorized - 25,000,000 Shares
 
 

 
 

     Issued and Outstanding: 2013 - 11,016,494; 2012 - 10,939,486
 
$
137,085

 
$
134,873

Retained Earnings
 
60,108

 
51,804

Accumulated Other Comprehensive Loss
 
(1,091
)
 
(1,328
)
Common Stockholders' Equity
 
196,102

 
185,349

Preferred Stock
 
772

 
772

Long-Term Debt
 
175,533

 
178,475

Total Capitalization
 
372,407

 
364,596

Current Portion of Long-Term Debt
 
4,103

 
1,304

Interim Bank Loans Payable
 
1,324

 
1,660

Accounts Payable and Accrued Expenses
 
7,432

 
10,016

Accrued Interest
 
1,450

 
889

Current Portion of Refund to Customers - Regulatory Liability
 
3,100

 

Other Current Liabilities
 
1,849

 
2,008

Total Current Liabilities
 
19,258

 
15,877

Advances for Construction
 
31,566

 
31,030

Contributions in Aid of Construction
 
77,346

 
77,372

Deferred Federal and State Income Taxes
 
45,537

 
40,869

Unfunded Future Income Taxes
 
41,442

 
8,992

Long-Term Compensation Arrangements
 
36,279

 
36,430

Unamortized Investment Tax Credits
 
1,435

 
1,490

Refund to Customers - Regulatory Liability
 
9,299

 

Other Long-Term Liabilities
 
1,033

 
2,319

Total Long-Term Liabilities
 
243,937

 
198,502

Commitments and Contingencies
 

 

Total Capitalization and Liabilities
 
$
635,602

 
$
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 September 30, 2013 and 2012
(Unaudited)
(In thousands, except per share amounts)
 
2013
 
2012
Operating Revenues
$
27,632

 
$
24,461

Operating Expenses
 
 
 
Operation and Maintenance
11,099

 
10,273

Depreciation
2,684

 
2,387

Income Taxes
1,659

 
2,098

Taxes Other Than Income Taxes
2,135

 
1,985

Total Operating Expenses
17,577

 
16,743

Net Operating Revenues
10,055

 
7,718

Other Utility Income, Net of Taxes
194

 
243

Total Utility Operating Income
10,249

 
7,961

Other Income (Deductions), Net of Taxes
 
 
 
Loss on Real Estate Transactions
(7
)
 
(31
)
Non-Water Sales Earnings
381

 
329

Allowance for Funds Used During Construction
79

 
59

Other
423

 
(156
)
Total Other Income, Net of Taxes
876

 
201

Interest and Debt Expense
 
 
 
Interest on Long-Term Debt
1,827

 
1,925

Other Interest (Income) Charges, Net
(142
)
 
172

Amortization of Debt Expense and Premium, Net
(2
)
 
91

Total Interest and Debt Expense
1,683

 
2,188

Net Income
9,442

 
5,974

Preferred Stock Dividend Requirement
10

 
10

Net Income Applicable to Common Stock
$
9,432

 
$
5,964

Weighted Average Common Shares Outstanding:
 
 
 
Basic
10,835

 
8,689

Diluted
11,006

 
8,829

Earnings Per Common Share:
 
 
 
Basic
$
0.87

 
$
0.69

Diluted
$
0.86

 
$
0.67

Dividends Per Common Share
$
0.2475

 
$
0.2425


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 Nine Months Ended September 30, 2013 and 2012
(Unaudited)
(In thousands, except per share amounts)

 
 
2013
 
2012
Operating Revenues
 
$
69,906

 
$
64,349

Operating Expenses
 
 

 
 

Operation and Maintenance
 
31,834

 
29,984

Depreciation
 
7,988

 
7,166

Income Taxes
 
5,306

 
5,244

Taxes Other Than Income Taxes
 
6,105

 
5,675

Total Operating Expenses
 
51,233

 
48,069

Net Operating Revenues
 
18,673

 
16,280

Other Utility Income, Net of Taxes
 
579

 
607

Total Utility Operating Income
 
19,252

 
16,887

Other Income (Deductions), Net of Taxes
 
 

 
 

(Loss) Gain on Real Estate Transactions
 
(7
)
 
951

Non-Water Sales Earnings
 
1,143

 
1,012

Allowance for Funds Used During Construction
 
209

 
194

Other
 
251

 
(597
)
Total Other Income, Net of Taxes
 
1,596

 
1,560

Interest and Debt Expense
 
 

 
 

Interest on Long-Term Debt
 
5,405

 
5,772

Other Interest (Income) Charges, Net
 
(842
)
 
359

Amortization of Debt Expense and Premium, Net
 
(80
)
 
269

Total Interest and Debt Expense
 
4,483

 
6,400

Net Income
 
16,365

 
12,047

Preferred Stock Dividend Requirement
 
29

 
29

Net Income Applicable to Common Stock
 
$
16,336

 
$
12,018

Weighted Average Common Shares Outstanding:
 
 

 
 

Basic
 
10,819

 
8,669

Diluted
 
10,987

 
8,805

Earnings Per Common Share:
 
 
 
 

Basic
 
$
1.51

 
$
1.39

Diluted
 
$
1.49

 
$
1.36

Dividends Per Common Share
 
$
0.7325

 
$
0.7175


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 September 30, 2013 and 2012
(Unaudited)
(In thousands)

 
2013
 
2012
Net Income
$
9,442

 
$
5,974

Other Comprehensive Income/(Loss), net of tax
 

 
 

Qualified Cash Flow Hedging Instrument Income, net of tax benefit of $12 and $1 in 2013 and 2012
40

 
1

Reclassification to Pension and Post-Retirement Benefits Other than Pension, net of tax (expense) benefit of $(34) in 2013 and $15 in 2012
22

 
(18
)
Unrealized gain on investments, net of tax expense of $31 in 2013 and $20 in 2012
54

 
30

Other Comprehensive Income, net of tax
116

 
13

Comprehensive Income
$
9,558

 
$
5,987





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

 
2013
 
2012
Net Income
$
16,365

 
$
12,047

Other Comprehensive Income/(Loss), net of tax

 

 
 
Qualified Cash Flow Hedging Instrument Income, net of tax benefit of $12 and $1 in 2013 and 2012
41

 
2

Reclassification to Pension and Post-Retirement Benefits Other Than Pension, net of tax (expense) benefit of $(80) in 2013 and $46 in 2012
89

 
(53
)
Unrealized gain on investments, net of tax expense of $66 in 2013 and $41 in 2012
107

 
61

Other Comprehensive Income, net of tax
237

 
10

Comprehensive Income
$
16,602

 
$
12,057



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 September 30, 2013 and 2012
(Unaudited)
(In thousands, except per share amounts)

 
2013
 
2012
Balance at Beginning of Period
$
53,395

 
$
48,544

Net Income
9,442

 
5,974

 
62,837

 
54,518

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 $0.2475 per share; 2012 $0.2425 per share
2,719

 
2,142

 
2,729

 
2,152

Balance at End of Period
$
60,108

 
$
52,366




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


 
2013
 
2012
Balance at Beginning of Period
$
51,804

 
$
46,669

Net Income
16,365

 
12,047

 
68,169

 
58,716

Dividends Declared:
 

 
 

Cumulative Preferred, Class A, $0.60 per share
9

 
9

Cumulative Preferred, Series $0.90, $0.675 per share
20

 
20

Common Stock - 2013 $0.7325 per share; 2012 $0.7175 per share
8,032

 
6,321

 
8,061

 
6,350

Balance at End of Period
$
60,108

 
$
52,366



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 Nine Months Ended September 30, 2013 and 2012
(Unaudited)
(In thousands)
 
2013
 
2012
Operating Activities:
 
 
 
Net Income
$
16,365

 
$
12,047

Adjustments to Reconcile Net Income to Net Cash Provided by
 

 
 

Operating Activities:
 

 
 

Deferred Revenues
(2,583
)
 
179

Provision for Deferred Income Taxes and Investment Tax Credits, Net
5,063

 
1,756

Allowance for Funds Used During Construction
(209
)
 
(194
)
Depreciation (including $533 and $330 in 2013 and 2012 charged to other accounts)
8,521

 
7,496

Loss (Gain) on Real Estate Transactions
7

 
(951
)
Change in Assets and Liabilities:
 

 
 

Increase in Accounts Receivable and Accrued Unbilled Revenues
(4,255
)
 
(4,745
)
Increase in Prepaid Income Taxes and Prepayments and Other Current Assets
(18,170
)
 
(2,173
)
Decrease in Other Non-Current Items
11,429

 
4,137

Increase in Accounts Payable, Accrued Expenses and Other Current Liabilities
1,876

 
930

Total Adjustments
1,679

 
6,435

Net Cash and Cash Equivalents Provided by Operating Activities
18,044

 
18,482

Investing Activities:
 

 
 

Company Financed Additions to Utility Plant
(22,703
)
 
(17,779
)
Advances from Others for Construction
(179
)
 
(53
)
Net Additions to Utility Plant Used in Continuing Operations
(22,882
)
 
(17,832
)
Purchase of water systems, net of cash acquired

 
(36,340
)
Proceeds from the Sale of Land
95

 
1,450

Release of Restricted Cash
1,295

 
6,117

Net Cash and Cash Equivalents Used in Investing Activities
(21,492
)
 
(46,605
)
Financing Activities:
 

 
 

Proceeds from Interim Bank Loans
1,324

 
22,617

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
(42
)
 
(254
)
Proceeds from Issuance of Common Stock
1,209

 
735

Proceeds from the Exercise of Stock Options

 
631

Repayment of Long-Term Debt Including Current Portion
(15,613
)
 
(871
)
Advances from Others for Construction
179

 
53

Cash Dividends Paid
(8,061
)
 
(6,350
)
Net Cash and Cash Equivalents (Used in) Provided by Financing Activities
(8,114
)
 
31,277

Net (Decrease) Increase in Cash and Cash Equivalents
(11,562
)
 
3,154

Cash and Cash Equivalents at Beginning of Period
13,150

 
1,012

Cash and Cash Equivalents at End of Period
$
1,588

 
$
4,166

Non-Cash Investing and Financing Activities:
 

 
 

Non-Cash Contributed Utility Plant
$
438

 
$
718

Short-term Investment of Bond Proceeds Held in Restricted Cash
$
9,938

 
$
9,819

Supplemental Disclosures of Cash Flow Information:
 

 
 

Cash Paid for:
 

 
 

Interest
$
4,126

 
$
5,123

State and Federal Income Taxes
$
2,550

 
$
4,337

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 Forms 10-Q for the periods ended March 31, 2013 and June 30, 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 Balance Sheet and 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 Water Infrastructure Conservation Act ("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. On September 18, 2013 the PURA approved the 1.09% surcharge with the new rates becoming effective on October 1, 2013. As of October 1, 2013, the cumulative WICA surcharge was 7.89%.

On June 28, 2013, Connecticut Water entered into a settlement agreement with the Office of the Consumer Counsel of the State of Connecticut and the Office of the Attorney General for the State of Connecticut (the "Settlement Agreement"), whereby

9


Connecticut Water would adjust the water rates charged to its customers effective April 1, 2014 in accordance with the elements of the Settlement Agreement (the "Connecticut Water Rate Reduction Plan"). On July 1, 2013, Connecticut Water submitted an application to the PURA seeking formal approval of the Settlement Agreement.

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

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

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

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

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

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

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

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

The rates we charge our Maine water customers are established under the jurisdiction of and are approved by the MPUC.  It is our policy to seek rate relief as necessary to enable us to achieve an adequate rate of return.  Maine Water’s average allowed return on equity and return on rate base, as of September 30, 2013 were 10.00% and 8.31%, respectively.  BSWC’s allowed return on equity, as of September 30, 2013, was 10.00%.

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


10


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

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

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 nine months ended September 30, 2013 and 2012.

Pension Benefits
Components of Net Periodic Cost (in thousands):
 
Three Months
 
Nine Months
Period ended September 30,
2013
 
2012
 
2013
 
2012
Service Cost
$
550

 
$
505

 
$
1,650

 
$
1,515

Interest Cost
696

 
642

 
2,087

 
1,927

Expected Return on Plan Assets
(799
)
 
(674
)
 
(2,397
)
 
(2,020
)
Amortization of:
 

 
 

 
 
 
 
Prior Service Cost
19

 
19

 
56

 
56

Net Loss
563

 
438

 
1,689

 
1,315

Net Periodic Benefit Cost
$
1,029

 
$
930

 
$
3,085

 
$
2,793


The Company made a contribution to its defined benefit pension plan of $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
 
Nine Months
Period ended September 30,
2013
 
2012
 
2013
 
2012
Service Cost
$
169

 
$
136

 
$
506

 
$
411

Interest Cost
127

 
136

 
381

 
406

Expected Return on Plan Assets
(73
)
 
(67
)
 
(218
)
 
(202
)
Other
57

 
57

 
169

 
169

Amortization of:
 

 
 

 
 
 
 
Transition Obligation

 
1

 

 
1

Prior Service Cost
(202
)
 
(202
)
 
(605
)
 
(605
)
Recognized Net Loss
108

 
152

 
323

 
458

Net Periodic Benefit Cost
$
186

 
$
213

 
$
556

 
$
638



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 September 30,
2013
 
2012
Common Shares Outstanding End of Period:
11,016,494

 
8,848,848

Weighted Average Shares Outstanding (Days Outstanding Basis):
 

 
 

Basic
10,834,532

 
8,689,116

Diluted
11,006,240

 
8,829,025

 
 
 
 
Basic Earnings per Share
$
0.87

 
$
0.69

Dilutive Effect of Unexercised Stock Options
(0.01
)
 
(0.02
)
Diluted Earnings per Share
$
0.86

 
$
0.67

 
 
 
 
Nine Months ended September 30,
 
 
 
Weighted Average Shares Outstanding (Days Outstanding Basis):
 
 
 
Basic
10,818,996

 
8,669,229

Diluted
10,986,731

 
8,805,061

 
 
 
 
Basic Earnings per Share
$
1.51

 
$
1.39

Dilutive Effect of Unexercised Stock Options
(0.02
)
 
(0.03
)
Diluted Earnings per Share
$
1.49

 
$
1.36


Total unrecognized compensation expense for all stock awards was approximately $1.0 million as of September 30, 2013 and will be recognized over a weighted average period of 1.1 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.

In July 2013, the FASB issued Accounting Standards Update ("ASU") No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This ASU requires an entity to present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss carryforward, or similar tax loss or tax credit carryforward, rather than as a liability when (1) the uncertain tax position would reduce the Net Operating Loss or other carryforward under the tax law of the applicable jurisdiction and (2) the entity intends to use the deferred tax asset for that purpose. This ASU is effective prospectively for fiscal years beginning after December 15, 2013. The Company does not expect that the adoption of this guidance will materially impact our consolidated financial position.


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 nine months ended September 30, 2013 is as follows (in thousands):
Three Months Ended September 30, 2013
 
Interest Rate Swap
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
(40
)
 
$
122

 
$
(1,289
)
 
$
(1,207
)
Other Comprehensive Income Before Reclassification
 

 
54

 

 
54

Amounts Reclassified from AOCI
 
40

 

 
22

 
62

Net current-period Other Comprehensive Income
 
40

 
54

 
22

 
116

Ending Balance
 
$

 
$
176

 
$
(1,267
)
 
$
(1,091
)
 
 
 
 
 
 
 
 
 
Nine Months Ended September 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
 

 
95

 

 
95

Amounts Reclassified from AOCI
 
41

 
12

 
89

 
142

Net current-period Other Comprehensive Income
 
41

 
107

 
89

 
237

Ending Balance
 
$

 
$
176

 
$
(1,267
)
 
$
(1,091
)
 
 
 
 
 
 
 
 
 
(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 nine months ended September 30, 2013 (in thousands):
Details about Other AOCI Components
 
Amounts Reclassified from AOCI Three Months Ended September 30, 2013(a)
 
Amounts Reclassified from AOCI Nine Months Ended September 30, 2013(a)
 
Affected Line Items on Income Statement
Amortization of Cash Flow Hedging Instrument
 
28

 
29

 
Other Income
Tax benefit
 
12

 
12

 
Other Income
 
 
40

 
41

 
 
 
 
 
 
 
 
 
Realized Gains on Investments
 

 
21

 
Other Income
Tax expense
 

 
(9
)
 
Other Income
 
 

 
12

 
 
 
 
 
 
 
 
 
Amortization of Recognized Net Gain from Defined Benefit Items
 
56

 
169

 
Other Income (b)
Tax expense
 
(34
)
 
(80
)
 
Other Income
 
 
22

 
89

 
 
 
 
 
 
 
 
 
Total Reclassifications for the period, net of tax
 
62

 
142

 
 
 
 
 
 
 
 
 
(a) Amounts in parentheses indicate loss/expense.
(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 September 30, 2013 and December 31, 2012 consisted of the following (in thousands):
 
2013
 
2012
Connecticut Water Service, Inc.:
 
 
 
4.09%
 
Term Loan Note
$
16,653

 
$
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
23,651

 
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
134,811

 
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
451

 
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
717

 
762

0.00%
 
2009 Series T, Due 2029
2,012

 
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
18,263

 
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
94

 
126

Total The Biddeford & Saco Water Company
8,557

 
8,589

Add:  Acquisition Fair Value Adjustment
1,352

 
1,696

Less:  Current Portion
(4,103
)
 
(1,304
)
Total Long-Term Debt
$
175,533

 
$
178,475


As of September 30, 2013, the Company and its subsidiaries will make principal payments of approximately $4,103,000 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 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 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 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 September 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 September 30, 2013 (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Asset Type:
 
 
 
 
 
 
 
Company Owned Life Insurance
$

 
$
2,719

 
$

 
$
2,719

Money Market Fund
115

 

 

 
115

Mutual Funds:
 

 
 

 
 

 
 

Equity Funds (1)
1,378

 

 

 
1,378

Total
$
1,493

 
$
2,719

 
$

 
$
4,212


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 consist 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 and Maine Water's June 2013 bond offerings, 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 and 2014, 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.


16

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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 September 30, 2013 and December 31, 2012, the estimated fair value of the Company's long-term debt was $181,160,000 and $194,900,000, respectively, as compared to the carrying amounts of $175,533,000 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 nine months ended September 30, 2013 include the results of BSWC. Financial data for the segments is as follows (in thousands):
Three Months Ended September 30, 2013
Segment
 
Revenues
 
Pre-Tax Income (Loss)
 
Income Tax Expense (Benefit)
 
Net Income (Loss)
Water Activities
 
$
27,982

 
$
10,294

 
$
1,226

 
$
9,068

Real Estate Transactions
 
95

 
(8
)
 
(1
)
 
(7
)
Services and Rentals
 
1,491

 
588

 
207

 
381

Total
 
$
29,568

 
$
10,874

 
$
1,432

 
$
9,442

Three Months Ended September 30, 2012
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense
 
Net Income (Loss)
Water Activities
 
$
24,919

 
$
7,795

 
$
2,119

 
$
5,676

Real Estate Transactions
 

 

 
31

 
(31
)
Services and Rentals
 
1,586

 
559

 
230

 
329

Total
 
$
26,505

 
$
8,354

 
$
2,380

 
$
5,974

Nine Months Ended September 30, 2013
Segment
 
Revenues
 
Pre-Tax Income (Loss)
 
Income Tax Expense (Benefit)
 
Net Income (Loss)
Water Activities
 
$
70,964


$
20,223

 
$
4,994

 
$
15,229

Real Estate Transactions
 
95


(8
)
 
(1
)
 
(7
)
Services and Rentals
 
4,357


1,875

 
732

 
1,143

Total
 
$
75,416

 
$
22,090

 
$
5,725

 
$
16,365

Nine Months Ended September 30, 2012
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense
 
Net Income
Water Activities
 
$
65,480

 
$
15,209

 
$
5,125

 
$
10,084

Real Estate Transactions
 
1,450

 
1,331

 
380

 
951

Services and Rentals
 
4,287

 
1,712

 
700

 
1,012

Total
 
$
71,217

 
$
18,252

 
$
6,205

 
$
12,047


The revenues shown in Water Activities above consisted of revenues from water customers of $27,632,000 and $24,461,000 for the three months ended September 30, 2013 and 2012, respectively.  Additionally, there were revenues associated with utility plant leased to others of $350,000 and $458,000 for the three months ended September 30, 2013 and 2012, respectively. The revenues shown in Water Activities above consisted of revenues from water customers of $69,906,000 and $64,349,000 for the nine months ended September 30, 2013 and 2012, respectively.  Additionally, there were revenues associated with utility plant leased to others of $1,058,000 and $1,131,000 for the nine months ended September 30, 2013 and 2012, respectively. The

17

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

revenues from water customers for the three and nine months ended September 30, 2013 include $2,762,000 in revenues related to the implementation of the RAM during the third quarter of 2013.

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 amount of tax benefits received for donations and the Company’s ability to use any benefits received from donations.  During the nine months ended September 30, 2013, the Company completed the sale of a small rental property in the Town of Killingly, CT. During the nine months ended September 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):
 
September 30,
2013
 
December 31,
2012
Total Plant and Other Investments:
 
 
 
Water Activities
$
468,240

 
$
453,625

Non-Water
705

 
680

 
468,945

 
454,305

Other Assets:
 
 
 
Water Activities
155,602

 
118,020

Non-Water
11,055

 
6,650

 
166,657

 
124,670

Total Assets
$
635,602

 
$
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 during the fourth quarter of 2013. 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 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 nine months ended September 30, 2013, the Company recorded a reserve of $2.3 million, or 100% of the credits recorded that would be subject to disallowance, of which approximately $0.9 million was recorded in the three months ended September 30, 2013.

On the 2012 tax return, filed in September 2013, the subsidiary Connecticut Water Company filed a change in accounting method to adopt the Internal Revenue Services' temporary tangible property regulations. This method change allowed the Company to take a current year deduction for expenses that were previously capitalized for tax purposes. Since the filing of the 2012 tax return, the IRS has issued final regulations. While the Company believes that the deduction taken on its tax return is appropriate, the methodology for determining the deduction could be challenged by the taxing authorities. Therefore, as required by FASB ASC 740, during the three and nine months ended September 30, 2013, the Company recorded a reserve of $2.2 million for a portion of the benefit that is not being returned to customers.

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 nine months ended September 30, 2013 and 2012.  Additionally, there were no accruals relating to interest or penalties as of September 30, 2013 and December 31, 2012.  The Company remains subject to examination by federal authorities for the 2010, 2011 and 2012 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 2013 Federal Tax Return to be filed in September 2014. As a result, through the third quarter of 2013, the

18


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 three months ended of September 30, 2013 and 2012 was 13.2% and 28.5%, respectively.  The Company's effective tax rate, excluding discrete items booked during the quarter, was 16.1% for the three months ended September 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, including the basis difference for the adoption of the tangible property regulations in the current year.

The Company’s effective income tax rate for the first nine months of 2013 and 2012 was 25.9% and 34.0%, respectively.  The Company's effective tax rate, excluding discrete items such as the tax reserves described above and the 2012 return to accrual true up, was 27.3% for the nine months ended September 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, including the basis difference for the adoption of the tangible property regulations in the current year.

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.  The Company maintains an additional line of credit of $20 million, with an expiration date of June 30, 2014.  On June 30, 2013, the Company allowed BSWC's $2.25 million line of credit to expire. As of September 30, 2013, the total lines of credit available to the Company was $35.0 million.  Interim Bank Loans Payable at September 30, 2013 and December 31, 2012 was approximately $1.3 million and $1.7 million, respectively, and represents the outstanding aggregate balances on these lines of credit. 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 September 30, 2013, the Company had $33.7 million in unused lines of credit.  Interest expense charged on interim bank loans will fluctuate based on market interest rates.

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.


19

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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


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 nine months ended September 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
 
Nine Months Ended
Operating Revenues
$
25,703

 
$
67,658

Other Water Activities Revenues
458

 
1,131

Real Estate Revenues

 
1,450

Service and Rentals Revenues
1,608

 
4,375

Total Revenues
$
27,769

 
$
74,614

 
 

 
 
Net Income
$
6,035

 
$
12,170

 
 

 
 
Basic Earnings per Average Share Outstanding
$
0.69

 
$
1.40

Diluted Earnings per Average Share Outstanding
$
0.68

 
$
1.38



20

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following table summarizes the results of BSWC for the three and nine months ended September 30, 2013, and is included in the Condensed Consolidated Statement of Income for the period (in thousands):
 
Three Months Ended
 
Nine Months Ended
Operating Revenues
$
1,134

 
$
3,173

Other Water Activities Revenues

 

Real Estate Revenues

 

Service and Rentals Revenues
22

 
85

Total Revenues
$
1,156

 
$
3,258

 
 

 
 
Net Income (Loss)
$
24

 
$
(75
)
 
 

 
 
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.

General Information

Acquisitions

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

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

On July 19, 2012, the Company announced that it had reached an agreement to acquire The Biddeford & Saco Water Company ("BSWC"), pending a vote of BSWC shareholders, approval by the MPUC and the satisfaction of other various conditions. This acquisition added approximately 15,500 additional customers in the State of Maine, in the communities of Biddeford, Saco, Old Orchard Beach and Scarborough. Under the terms of the agreement, the acquisition was executed through a stock-for-stock merger transaction valued at approximately $12.0 million. On November 7, 2012, the MPUC approved the transaction and the Company completed the transaction on December 10, 2012. Holders of BSWC common stock received an aggregate of 380,254 shares of the Company's common stock in a tax-free exchange. The Company is accounting for the acquisition in accordance with FASB ASC 805. The Company is still in the process of completing the purchase price allocation as required by FASB ASC 805. See Note 11 in Part I, Item1 for more information.

UCONN Proposal

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


21


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

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

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

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

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

Public Utility Regulatory Authority Matters

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

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

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

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

On January 25, 2013, Connecticut Water filed a WICA application with the PURA requesting an additional 1.08% surcharge to customer bills related to approximately $6.5 million spending on WICA projects. This application also reduced the surcharge by 0.09% for the prior year reconciliation adjustment which expired April 1, 2013.  On January 30, 2013, Connecticut Water

22


filed for a 0.10% reconciliation adjustment for the 2012 shortfall in WICA, to become effective April 1, 2013.  On March 25, 2013, the PURA approved an additional 1.06% surcharge, effective April 1, 2013. Additionally, on March 27, 2013, the PURA approved a 0.10% reconciliation adjustment, effective April 1, 2013. As of April 1, 2013, Connecticut Water's cumulative WICA surcharge was 6.80%.

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

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

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

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

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

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

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

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

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

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

23


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

The rates we charge our Maine water customers are established under the jurisdiction of and are approved by the MPUC.  It is our policy to seek rate relief as necessary to enable us to achieve an adequate rate of return.  Maine Water’s average allowed return on equity and return on rate base, as of September 30, 2013 were 10.00% and 8.31%, respectively.  BSWC’s allowed return on equity, as of September 30, 2013, was 10.00%.

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

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

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


Critical Accounting Policies and Estimates

The Company maintains its accounting records in accordance with accounting principles generally accepted in the United States of America and as directed by the PURA and the MPUC to which Connecticut Water, Maine Water and BSWC, respectively, the Company’s regulated water utility subsidiaries, are subject.  Significant accounting policies employed by the Company, including the use of estimates, were presented in the Notes to Consolidated Financial Statements of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

Critical accounting policies are those that are the most important to the presentation of the Company’s financial condition and results of operations.  The application of such accounting policies requires management’s most difficult, subjective, and complex judgments and involves uncertainties and assumptions.  The Company’s most critical accounting policies pertain to public utility regulation related to ASC 980 “Regulated Operations”, revenue recognition (including the Revenue Adjustment Mechanism), and accounting for pension and other post-retirement benefit plans.  Each of these accounting policies and the application of critical accounting policies and estimates were discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

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

Outlook

The following modifies and updates the “Outlook” section of the Company’s 2012 Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

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


24


The Company expects Net Income from its Water Activities segment to increase in 2013 over 2012 levels, based, in part, on the implementation of the RAM, the adoption of the tax accounting method change and the continued utilization of WICA, along with modest growth in its Services and Rentals segment.

The Company believes that the factors described above and those described in detail below under the heading “Commitments and Contingencies” below may have significant impact, either alone or in the aggregate, on the Company’s earnings and profitability in fiscal years 2013 and beyond.  Please also review carefully the risks and uncertainties described in the sections entitled Item 1A – Risk Factors, “Commitments and Contingencies” in Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012 and the risks and uncertainties described in the “Forward-Looking Information” section below.

Liquidity and Capital Resources

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

Borrowing Facilities

On June 30, 2009, the Company entered into a $15 million line of credit agreement with CoBank, ACB ("CoBank"), which was amended in May 2010, July 2011 and September 2012 and is currently scheduled to expire on July 1, 2014.  The Company maintains an additional line of credit of $20 million, with an expiration date of June 30, 2014.  On June 30, 2013, the Company allowed BSWC's $2.25 million line of credit to expire. As of September 30, 2013, the total lines of credit available to the Company was $35.0 million.  Interim Bank Loans Payable at September 30, 2013 and December 31, 2012 was approximately $1.3 million and $1.7 million, respectively, and represents the outstanding aggregate balances on these lines of credit. The Company used a portion of the $47.5 million of net proceeds of its December 2012 equity issuance to pay down a portion of its outstanding balances on these lines of credit. As of September 30, 2013, the Company had $33.7 million in unused lines of credit.  Interest expense charged on interim bank loans will fluctuate based on market interest rates.

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

Under one Term Loan Note and Supplement, CoBank loaned the Company $18.0 million, which Term Loan shall be repaid by the Company in 60 equal quarterly installments of principal and interest over a 15-year amortizing term, with the first installment paid on April 20, 2012 and the last installment due on January 20, 2027.  Under the other Term Loan Note and Supplement, as amended in September 2012, CoBank loaned the Company $18.1 million, which Term Loan shall be repaid by the Company in quarterly interest payments and repayment of the principal balance in full on the earlier of January 2, 2014 or upon the Company raising equity capital, in the aggregate, up to the outstanding amount owed under the second Term Note and Supplement. On December 12, 2012, the Company issued approximately 1.7 million shares of common stock and used a portion of the proceeds to pay off the second Term Note. See "December 2012 Equity Issuance" below for more detail.

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

On October 29, 2012, Connecticut Water entered into a Master Loan Agreement (the “Agreement”) with CoBank. Connecticut Water also delivered to CoBank four Promissory Note and Single Advance Term Loan Supplements, each dated October 29, 2012 (the “Promissory Notes”).  On the terms and subject to the conditions set forth in the Promissory Notes issued pursuant to the Agreement, CoBank agreed to make unsecured loans (each a “Loan,” and collectively the “Loans”) to Connecticut Water from time to time, in an aggregate principal amount of up to $54,645,000. Connecticut Water used substantially all of the proceeds of the Loans to refinance the 1998 Series A, 1998 Series B, 2003A Series, 2003C Series and 2005A Series bonds outstanding.  Subject to the payment of a surcharge described in the Agreement for Loans bearing interest at fixed rates, Connecticut Water may prepay the Loans in whole or in part at any time prior to each of the maturity dates of each Loan.

25



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

On March 5, 2013, Connecticut Water and CoBank entered into a Promissory Note and Single Advance Term Loan Supplement to the MLA (the “Note”) in which CoBank agreed to make an additional Loan to Connecticut Water in an aggregate principal amount of up to $14,550,000, with a maturity date of March 4, 2033. Additionally, the Company entered into an Amendment to the Guarantee dated March 5, 2013 (the “Guarantee Amendment”), pursuant to which the Company agreed to guarantee the payment of certain of Connecticut Water's obligations under the Note pursuant to the same terms of the Guarantee. Connecticut Water used substantially all of the proceeds of the Loans to refinance the 2007 A Series bonds outstanding.

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

Credit Rating

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

Stock Plans

The Company offers a dividend reinvestment and stock purchase plan (“DRIP”) to all registered shareholders, and to the customers and employees of our regulated water companies, whereby participants can opt to have dividends directly reinvested into additional shares of the Company.  In August 2011, the Board of Directors approved amendments to the DRIP (effective as of January 1, 2012) that permit the Company to add, at the Company’s discretion, an “up to 5.00% purchase price discount” feature to the DRIP and are intended to encourage greater shareholder, customer and employee participation in the DRIP.  During the nine months ended September 30, 2013 and 2012, plan participants invested $1,209,000 and $735,000, respectively, in additional shares as part of the DRIP.

From 1999 through 2003, the Company issued stock options to certain employees of the Company.  No stock options have been issued by the Company since 2003.  During the nine months ended September 30, 2013, no stock options were exercised.  During the nine months ended September 30, 2012, 5,671 stock options were exercised, resulting in approximately $631,000 in proceeds to the Company.

December 2012 Equity Issuance

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 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 the 2013 construction budget.


26


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 the WISC recently approved by 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 September 30
Net Income for the three months ended September 30, 2013 increased from the same period in the prior year by $3,468,000 to $9,442,000. Earnings per basic average common share increased by $0.18 to $0.87 during the three months ended September 30, 2013.

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

Business Segment
 
September 30, 2013
 
September 30, 2012
 
Increase/(Decrease)
Water Activities
 
$
9,068

 
$
5,676

 
$
3,392

Real Estate Transactions
 
(7
)
 
(31
)
 
24

Services and Rentals
 
381

 
329

 
52

Total
 
$
9,442

 
$
5,974

 
$
3,468


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

Revenue

Revenue from our water customers increased by $3,171,000, or 13.0%, to $27,632,000 for the three months ended September 30, 2013 when compared to the same period in 2012.  The primary reason for the increase in revenues was the implementation of the RAM in the third quarter of 2013 which contributed $2,762,000 in additional revenue in the period which represented the amount by which actual revenues in the first nine months of 2013 were less than the revenues allowed in Connecticut Water's most recent general rate proceeding for the nine month period. In future periods, Connecticut Water will record the RAM on a monthly basis, based upon our actual billing compared to approved rates, including WICA surcharges and record a regulatory asset or liability for future collection from or refund to customers. Additionally, BSWC contributed an additional $1,134,000 in revenue during the period. Excluding BSWC and the implementation of the RAM, the Company saw a decrease in revenue from water customers of $725,000, or approximately 3.0% during the three months ended September 30, 2013. The primary driver for the decrease in revenue in 2013 was a general decline in usage among all customer classes.


27


Operation and Maintenance Expense

Operation and Maintenance (“O&M”) expense increased by $826,000, or 8.0%, for the three months ended September 30, 2013 when compared to the same period of 2012 primarily due to the acquisition of BSWC, which contributed $785,000 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 September 30, 2013 O&M
 
Actual September 30, 2012 O&M
 
Actual Increase / (Decrease)
 
BSWC September 30, 2013 O&M
 
Adjusted Increase / (Decrease)
Pension
 
$
1,048

 
$
931

 
$
117

 
$
27

 
$
90

Customer costs
 
407

 
337

 
70

 
26

 
44

Medical
 
644

 
495

 
149

 
120

 
29

Property liability insurance
 
291

 
264

 
27

 
10

 
17

Purchased water
 
438

 
462

 
(24
)
 

 
(24
)
Post-retirement medical
 
187

 
213

 
(26
)
 

 
(26
)
Regulatory commission expense
 
85

 
113

 
(28
)
 

 
(28
)
Utility costs
 
932

 
897

 
35

 
77

 
(42
)
Maintenance
 
714

 
691

 
23

 
68

 
(45
)
Other benefits
 
276

 
334

 
(58
)
 

 
(58
)
Payroll
 
3,549

 
3,418

 
131

 
220

 
(89
)
Water treatment (including chemicals)
 
856

 
881

 
(25
)
 
79

 
(104
)
Other
 
1,672

 
1,237

 
435

 
158

 
277

Total
 
$
11,099

 
$
10,273

 
$
826

 
$
785

 
$
41


The increase in O&M expenses excluding the incremental expense as a result of the acquisition of BSWC, was approximately $41,000, or approximately 0.4%, in the third quarter of 2013 when compared to the same period in 2012.  The changes in individual items, excluding the impact of BSWC, are described below:
The increase in Pension costs was attributable primarily to a decrease in the discount rate used in determining net periodic benefit costs in 2013;
Customer costs increased primarily due to an increase in uncollectible accounts in the third quarter of 2013 when compared to the same period of 2012; and
The primary driver in the increase in Other expense was due to the mark-to-market adjustment related to employee stock awards. The Company adjusts the value of those stock awards at the end of each reporting period based on the Company’s stock price on the last day of that period.

The increases described above were partially offset by the following decreases to O&M expense:
Payroll costs decreased primarily due to a decrease in the number employees at September 30, 2013 when compared to September 30, 2012, excluding BSWC employees, and the capitalization of various ongoing projects that began throughout 2013; and
Water treatment costs decreased primarily due to a reduction in the costs to dispose of waste generated at treatment plants.

The Company saw an approximate 12.4% increase in its Depreciation expense from the three months ended September 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 5.4% for the three months ended September 30, 2013. The remainder of the increase in Depreciation expense was due to higher Utility Plant in Service as of September 30, 2013 compared to September 30, 2012.

Income Tax expense decreased by $439,000 in the third quarter of 2013 when compared to the same period in 2012 due to a lower effective income tax rate and higher pre-tax net income. Excluding the impact of BSWC, Income Tax expense decreased by $448,000. The Company's effective tax rate decreased from 28.5% to 13.2% in the three months ended September 30, 2013 and 2012. The adjustment to the reserve for the fixed capital credits and reserve for the adoption of the tangible property regulations offset a portion of the return to accrual for the 2012 tax return.


28


Other Income (Deductions), Net of Taxes increased for the three months ended September 30, 2013 by $675,000. The primary driver of this increase was the tax benefits arising from the Company's income tax provision to income tax return analysis during three months ended September 30, 2013. Additionally, during the three months ended September 30, 2012 the Company incurred costs associated with the acquisition of BSWC.

Total Interest and Debt Expense decreased by $505,000 in three months ended September 30, 2013 when compared to the same period in 2012 due to an increase in the patronage income received from one of our banking partners and a decrease in Interest on Long-Term Debt due to the refinancing of approximately $54.6 million in long-term debt in the fourth quarter of 2012 and 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.

Nine months ended September 30
Net Income for the nine months ended September 30, 2013 increased from the same period in the prior year by $4,318,000 to $16,365,000. Earnings per basic average common share increased by $0.12 to $1.51 during the nine months ended September 30, 2013.

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

Business Segment
 
September 30, 2013
 
September 30, 2012
 
Increase/(Decrease)
Water Activities
 
$
15,229

 
$
10,084

 
$
5,145

Real Estate Transactions
 
(7
)
 
951

 
(958
)
Services and Rentals
 
1,143

 
1,012

 
131

Total
 
$
16,365

 
$
12,047

 
$
4,318


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 $5,557,000, or 8.6%, to $69,906,000 for the nine months ended September 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 $3,173,000 in revenue during the nine months ended September 30, 2013. Additionally, the implementation of the RAM in the third quarter of 2013 contributed $2,762,000 in additional revenue in the period which represented the amount by which actual revenues in the first nine months of 2013 were less than the revenues allowed in Connecticut Water's most recent general rate proceeding for the nine month period. In future periods, Connecticut Water will record the RAM on a monthly basis, based upon our actual billing compared to approved rates, including WICA surcharges and record a regulatory asset or liability for future collection from or refund to customers. Excluding BSWC and the implementation of RAM, the Company saw a decrease in revenue from water customers of $378,000, or approximately 0.6% during the nine months ended September 30, 2013. The primary driver for the decrease in revenue in 2013 was a general decline in usage among all customer classes.


29


Operation and Maintenance Expense

Operation and Maintenance (“O&M”) expense increased by $1,850,000, or 6.2%, for the nine months ended September 30, 2013 when compared to the same period of 2012 primarily due to the acquisition of BSWC, which contributed $2,383,000 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 September 30, 2013 O&M
 
Actual September 30, 2012 O&M
 
Actual Increase / (Decrease)
 
BSWC September 30, 2013 O&M
 
Adjusted Increase / (Decrease)
Customer
 
$
1,135

 
$
769

 
$
366

 
$
114

 
$
252

Outside services
 
1,608

 
1,099

 
509

 
296

 
213

Pension
 
3,060

 
2,793

 
267

 
82

 
185

Maintenance
 
2,007

 
1,737

 
270

 
170

 
100

Investor relations
 
579

 
487

 
92

 

 
92

Purchased water
 
1,128

 
1,089

 
39

 

 
39

Post retirement medical
 
557

 
638

 
(81
)
 

 
(81
)
Utility costs
 
2,817

 
2,743

 
74

 
190

 
(116
)
Amston Lake water quality monitoring costs (non-labor)
 

 
135

 
(135
)
 

 
(135
)
Other benefits
 
726

 
906

 
(180
)
 

 
(180
)
Medical
 
2,062

 
1,862

 
200

 
390

 
(190
)
Water treatment (including chemicals)
 
2,141

 
2,238

 
(97
)
 
214

 
(311
)
Payroll
 
10,586

 
10,167

 
419

 
751

 
(332
)
Other
 
3,428

 
3,321

 
107

 
176