Washington, D.C. 20549
Connecticut Water Service, Inc.
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.
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 (Check One).
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date
(Includes 48,318 common stock equivalent shares awarded under the Performance Stock Programs)
The accompanying notes are an integral part of these financial statements.
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
1. Summary of Significant Accounting Policies
The consolidated financial statements included herein have been prepared by CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES (the “Company”), without audit, 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. 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 Balance Sheet at December 31, 2007 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 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, 2007 and as updated in the Company’s March 31, 2008 Form 10-Q.
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.
Reclassifications
Certain reclassifications have been made to conform previously reported data to the current presentation.
2. Pension and Other Post-Retirement Benefits
The following tables set forth the components of pension and other post-retirement benefit costs for the three and six months ended June 30, 2008 and 2007.
Pension Benefits
Components of Net Periodic Cost (in thousands):
| | | Three Months | | | Six Months | |
| Period ended June 30 | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| Service Cost | | $ | 324 | | | $ | 320 | | | $ | 630 | | | $ | 639 | |
| Interest Cost | | | 488 | | | | 447 | | | | 953 | | | | 894 | |
| Expected Return on Plan Assets | | | (532 | ) | | | (504 | ) | | | (1,060 | ) | | | (1,008 | ) |
| Amortization of: | | | | | | | | | | | | | | | | |
| Transition Obligation | | | -- | | | | -- | | | | 1 | | | | 1 | |
| Prior Service Cost | | | 17 | | | | 17 | | | | 34 | | | | 34 | |
| Net Loss | | | 46 | | | | 86 | | | | 71 | | | | 172 | |
| Net Periodic Benefit Cost | | $ | 343 | | | $ | 366 | | | $ | 629 | | | $ | 732 | |
The Company plans to make a contribution of approximately $3,500,000 for plan year 2007 during the third quarter of 2008.
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
Other Post-Retirement Benefits
Components of Net Periodic Cost (in thousands):
| | | Three Months | | | Six Months | |
| Period ended June 30 | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| Service Cost | | $ | 130 | | | $ | 153 | | | $ | 316 | | | $ | 325 | |
| Interest Cost | | | 138 | | | | 161 | | | | 329 | | | | 306 | |
| Expected Return on Plan Assets | | | (68 | ) | | | (48 | ) | | | (136 | ) | | | (95 | ) |
| Amortization of Transition Obligation | | | 30 | | | | 30 | | | | 60 | | | | 60 | |
| Recognized Net Loss | | | 11 | | | | 100 | | | | 101 | | | | 171 | |
| Net Periodic Benefit Cost | | $ | 241 | | | $ | 396 | | | $ | 670 | | | $ | 767 | |
The Company has concluded that the post-retirement welfare plan’s benefits will be considered actuarially equivalent to the benefits provided by Medicare Part D. The Company does not intend to apply for the government subsidy for post-retirement prescription drug benefits, because it believes the costs associated with the administration of Medicare Part D would have outweighed the benefits received by the Company. Therefore, the impact of the subsidy on the plan’s liabilities is not reflected in the June 30, 2008 disclosure.
3. Earnings per Share
Earnings per weighted average common share are calculated by dividing net income applicable to common stock by the weighted average number of shares of common stock outstanding during the respective periods as detailed below (diluted shares include the effect of unexercised stock options):
| Three months ended June 30, | | 2008 | | | 2007 | |
| Common Shares Outstanding | | | | | | |
| End of Period: | | | 8,430,354 | | | | 8,312,806 | |
| Weighted Average Shares Outstanding: | | | | | | | | |
| Days Outstanding Basis | | | | | | | | |
| Basic | | | 8,367,559 | | | | 8,249,113 | |
| Diluted | | | 8,421,149 | | | | 8,259,976 | |
| | | | | | | | | |
| Basic Earnings per Share | | $ | 0.35 | | | $ | 0.22 | |
| Dilutive Effect of Unexercised Stock Options | | | -- | | | | -- | |
| Diluted Earnings per Share | | $ | 0.35 | | | $ | 0.22 | |
| | | | | | | | | |
| Six months ended June 30, | | | | | | | | |
| Weighted Average Shares Outstanding: | | | | | | | | |
| Days Outstanding Basis | | | | | | | | |
| Basic | | | 8,358,722 | | | | 8,240,816 | |
| Diluted | | | 8,411,012 | | | | 8,251,285 | |
| | | | | | | | | |
| Basic Earnings per Share | | $ | 0.55 | | | $ | 0.40 | |
| Dilutive Effect of Unexercised Stock Options | | | -- | | | | -- | |
| Diluted Earnings per Share | | $ | 0.55 | | | $ | 0.40 | |
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
Total unrecognized compensation expense for all stock awards was approximately $1,098,000 as of June 30, 2008.
4. New Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurement” (SFAS 157). SFAS 157 provides a single definition of fair value, a framework for measuring fair value, and requires additional disclosure about the use of fair value to measure assets and liabilities. SFAS 157 is effective for fiscal years beginning after November 15, 2007; as such we partially adopted SFAS 157 in the first quarter of 2008. In February 2008, the FASB issued FASB Staff Position 157-2, “Effective Date of FASB Statement No. 157”, (SFP 157-2), which delays the effective date of SFAS 157 for non-financial assets and liabilities that are recognized or disclosed in the financial statements on a nonrecurring basis to fiscal years beginning after November 15, 2008. We have not applied the provisions of SFAS 157 to our non-financial assets and non-financial liabilities in accordance with FSP 157-2. Please see Note 5 for additional disclosures regarding fair value.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115” (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of SFAS 159 is to reduce both the complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 was effective for fiscal years beginning after November 15, 2007. The Company did not elect the fair value option for any of its existing financial instruments and has not determined whether or not to elect this option for financial instruments it may acquire in the future.
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (Revised 2007) “Business Combinations” (SFAS 141(R)), which establishes principles and requirements for how the acquiring company shall recognize and measure in its financial statements the identifiable assets acquired, liabilities assumed, any non-controlling interest in the acquired company and goodwill acquired in a business combination. This statement is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company is currently assessing the potential impact that the adoption of SFAS 141(R) will have on its financial position and results of operations.
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Non-controlling Interests in Consolidated Financial Statements — an Amendment of ARB No. 51” (SFAS 160), which establishes and expands accounting and reporting standards for minority interests, which will be recharacterized as non-controlling interests, in a subsidiary and the deconsolidation of a subsidiary. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. The Company is currently assessing the potential impact that the adoption of SFAS 160 will have on its financial position and results of operations.
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133” (SFAS 161). SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities. Under SFAS 161, entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This statement is effective for fiscal years and interim periods beginning after November 15, 2008. The Company is currently assessing the impact of SFAS 161.
In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (SFAS 162). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in preparation of financial statements presented in conformity with generally accepted accounting principles (GAAP). SFAS 162 directs the hierarchy to the entity, rather than the independent auditors, as the entity is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. SFAS 162 is effective 60 days following SEC approval of the Public Company Accounting Oversight Board amendments to remove the hierarchy of GAAP from the auditing standards. The Company does not expect SFAS 162 to have a material impact on its financial condition or results of operations.
In June 2008, the FASB issued FASB Staff Position EITF 03-6-1 (EITF 03-6-1), “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities.” EITF 03-6-1 states that unvested awards of share-based payments with rights to receive dividends or dividend equivalents are considered participating securities for purposes of calculating earnings per share. As a result, these participating securities will be included in the weighted average number of shares outstanding as disclosed on the face of the income statement. EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior period earnings per share data presented in financial reports after the effective date shall be adjusted retrospectively to conform to the provisions of EITF 03-6-1. Early application is not permitted. The Company does not expect EITF 03-6-1 to have a material impact on its reported earnings per share.
5. Fair Value Disclosures
The Company partially adopted SFAS 157 as of January 1, 2008, which among other things requires enhanced disclosures for assets and liabilities that are measured and reported at fair value and establishes a framework for measuring fair value. SFAS 157 applies to accounting pronouncements that already require or permit fair value measures and does not require any new fair value measurements.
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
SFAS 157 establishes a fair value hierarchy that distinguishes between assumptions based on market data (observable inputs) and the Company’s assumptions (unobservable inputs). The hierarchy consists of three broad levels, as follows:
Level 1 – Quoted market prices in active markets for identical assets or liabilities
Level 2 – Inputs other than Level 1 that are either directly or indirectly observable
Level 3 – Unobservable inputs developed using the Company’s estimates and assumptions, which reflect those that the Company believes market participants would use.
The following table summarizes our financial instruments measured at fair value on a recurring basis within the fair value hierarchy as of June 30, 2008:
| (in thousands) | | Level 1 | | | Level 2 | | | Level 3 | |
| Liabilities: | | | | | | | | | |
| Interest Rate Swap | | $ | - | | | $ | 64 | | | $ | - | |
In February 2008, the FASB issued FSP No. 157-2 which allows companies to elect a one year deferral of adoption of SFAS No. 157 for non-financial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company has elected the deferral option permitted by FSP No. 157-2 for its non-recurring non-financial assets and non-financial liabilities. Non-recurring non-financial assets and non-financial liabilities for which the Company has not applied the provisions of SFAS 157 include those measured at fair value in goodwill impairment testing.
6. Segment Reporting
The Company operates principally in three business segments: Water Activities, Real Estate Transactions, and Services and Rentals. Financial data for the segments is as follows (in thousands):
| Three Months Ended June 30, 2008 | |
| Segment | | Revenues | | | Pre-Tax Income | | | Income Tax Expense | | | Net Income | |
| Water Activities | | $ | 16,259 | | | $ | 3,985 | | | $ | 1,238 | | | $ | 2,747 | |
| Real Estate Transactions | | | -- | | | | -- | | | | -- | | | | -- | |
| Service and Rentals | | | 1,270 | | | | 339 | | | | 135 | | | | 204 | |
| Total | | $ | 17,529 | | | $ | 4,324 | | | $ | 1,373 | | | $ | 2,951 | |
| Three Months Ended June 30, 2007 | |
| Segment | | Revenues | | | Pre-Tax Income | | | Income Tax Expense | | | Net Income | |
| Water Activities | | $ | 14,698 | | | $ | 2,604 | | | $ | 923 | | | $ | 1,681 | |
| Real Estate Transactions | | | -- | | | | -- | | | | -- | | | | -- | |
| Service and Rentals | | | 1,083 | | | | 298 | | | | 117 | | | | 181 | |
| Total | | $ | 15,781 | | | $ | 2,902 | | | $ | 1,040 | | | $ | 1,862 | |
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
| Six Months Ended June 30, 2008 | |
| Segment | | Revenues | | | Pre-Tax Income | | | Income Tax Expense | | | Net Income | |
| Water Activities | | $ | 30,074 | | | $ | 6,190 | | | $ | 1,928 | | | $ | 4,262 | |
| Real Estate Transactions | | | -- | | | | -- | | | | -- | | | | -- | |
| Service and Rentals | | | 2,337 | | | | 646 | | | | 252 | | | | 394 | |
| Total | | $ | 32,411 | | | $ | 6,836 | | | $ | 2,180 | | | $ | 4,656 | |
| Six Months Ended June 30, 2007 | |
| Segment | | Revenues | | | Pre-Tax Income | | | Income Tax Expense | | | Net Income | |
| Water Activities | | $ | 28,088 | | | $ | 4,596 | | | $ | 1,623 | | | $ | 2,973 | |
| Real Estate Transactions | | | 92 | | | | 68 | | | | 27 | | | | 41 | |
| Service and Rentals | | | 1,987 | | | | 532 | | | | 209 | | | | 323 | |
| Total | | $ | 30,167 | | | $ | 5,196 | | | $ | 1,859 | | | $ | 3,337 | |
The Revenues shown in Water Activities above consist of revenues from water customers of $16,020,000 and $14,446,000 for the three months ended June 30, 2008 and 2007, respectively. Additionally, there were revenues associated with utility plant leased to others of $239,000 and $252,000 for the three months ended June 30, 2008 and 2007, respectively. The Water Activities revenues for the six months ended June 30, 2008 and 2007 consist of revenues from water customers of $29,589,000 and $27,608,000, respectively. Additionally, there were revenues associated with utility plant leased to others of $485,000 and $480,000 for the six months ended June 30, 2008 and 2007, respectively.
Assets by segment (in thousands):
| | | June 30, 2008 | | | December 31, 2007 | |
| Total Plant and Other Investments: | | | | | | |
| Water | | $ | 294,400 | | | $ | 283,641 | |
| Non-Water | | | 666 | | | | 673 | |
| | | | 295,066 | | | | 284,314 | |
| Other Assets: | | | | | | | | |
| Water | | | 76,124 | | | | 73,421 | |
| Non-Water | | | 3,022 | | | | 3,078 | |
| | | | 79,146 | | | | 76,499 | |
| Total Assets | | $ | 374,212 | | | $ | 360,813 | |
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
7. Income Taxes
From time to time, the Company is assessed interest and penalties by taxing authorities. In those cases, the charges would appear on the Other line item on the Income Statement. There were no such charges for the six month periods ended June 30, 2008 and 2007. Additionally, there were no accruals relating to interest or penalties as of June 30, 2008 and December 31, 2007. The Company remains subject to examination by federal authorities for the 2005 through 2007 tax years and by state authorities for the tax years 2003 through 2007.
The Company’s effective income tax rates for the first six months of 2008 and 2007 were 31.9% and 35.8%, respectively. The statutory income tax rates during the same periods were 39%. In determining its effective income tax rate for interim periods, the Company projects its book and tax timing differences for the complete year and reflects the expected impact on its overall effective income tax rate. The primary timing difference causing the effective rate to be lower than the statutory rate for both periods is the planned pension contribution that is greater than the SFAS 87 pension expense.
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
Part I, Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
Regulatory Matters and Inflation
During the three months ended June 30, 2008, there were no material changes under this subheading to any items previously disclosed by the Company in its Annual Report on Form 10-K for the period ended December 31, 2007.
In April 2006, the Connecticut Department of Utility Control (DPUC) approved the Company’s application to merge Unionville Water Company (Unionville) and Crystal Water Company (Crystal) into The Connecticut Water Company (Connecticut Water). The Company completed these mergers on May 31, 2006. In July 2006, the Company filed a rate application with the DPUC for the newly merged Connecticut Water requesting an increase in rates of approximately $14.6 million, or 30%. On January 16, 2007, the DPUC issued its final decision and approved a Settlement Agreement; negotiated with the Office of Consumer Counsel and the DPUC’s Prosecutorial Staff; that allowed Connecticut Water an increase of revenues of approximately $10,940,000, or 22.3%. The Settlement Agreement allowed Connecticut Water to defer a portion of the approved rate increase. The Company recognized that increase through recording deferred revenues and a corresponding regulatory asset, as required by the decision. From January 1, 2007 through March 31, 2008, the Company has recorded approximately $4.8 million in deferred revenues. On January 31, 2008, the Company filed to reopen the case, a procedure required by the Settlement Agreement, to implement the second phase. In addition to the approval for the inclusion in current rates of the previously approved deferred revenues of $4.8 million, the filing included requested recovery of the costs associated with $15.5 million of additional capital investments made in 2007. This portion of the second phase of the increase (“re-opener”) was also called for in the Settlement Agreement.
The total increase associated with the re-opener was a request of 12.6%, of which approximately 8.2% is for deferred revenues and 4.4% for the investment in additional capital in 2007. Additionally, Connecticut Water agreed not to apply for a general rate increase that would become effective prior to January 1, 2010.
The final decision on the re-opener was issued on March 28, 2008. The decision allowed an increase of water rates charged to customers of 11.95% or $6.7 million, effective April 1, 2008. The Company began to see the effects of this increase in the second quarter of 2008.
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
Acquisition of the assets of Eastern Connecticut Regional Water Company and Birmingham H20 Services
On January 16, 2008, the Company, through two of its wholly owned subsidiaries, Connecticut Water and New England Water Utility Services, Inc. (NEWUS), completed the acquisition of the regulated water utility assets of Eastern Connecticut Regional Water Company, Inc. (Eastern) and the unregulated assets of Birmingham H2O Services, Inc. (H20) for aggregate cash consideration of $3.5 million. Eastern brings approximately 2,300 customers in 14 Connecticut towns to the Company.
Announcement of acquisition of Ellington Acres Company
On July 23, 2008, the Company announced that it had reached a definitive agreement with Ellington Acres Company (EAC) to purchase all of EAC’s outstanding stock for approximately $1.5 million. EAC is a regulated water company serving approximately 750 customers in Ellington, Connecticut. EAC is situated between two systems in the Company’s Northern Region that the Company had planned to interconnect. With this acquisition, the Company will be able to interconnect the two current systems with EAC, saving the ratepayers of Connecticut Water and EAC significant capital expenditures. The acquisition of EAC is dependent upon regulatory approval from the DPUC. A decision is expected late in the fourth quarter of 2008 or early in the first quarter of 2009. A copy of the stock purchase agreement is filed as an exhibit to this Form 10-Q as Exhibit 10.1.
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 DPUC to which Connecticut Water, the Company’s regulated water utility subsidiary, is 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.
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 Financial Accounting Standards No. 71, “Accounting for the Effects of Certain Types of Regulations” (SFAS 71), revenue recognition, and pension plan accounting. Each of these accounting policies and the application of critical accounting policies and estimates was discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007. There were no significant changes in the application of critical accounting policies or estimates during the first six months of 2008. Please see Note 4 of the financial statements for newly adopted and recently announced accounting standards.
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.
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
Outlook
The following modifies and updates the “Outlook” section of the Company’s 2007 Form 10-K annual report filed on March 17, 2008 and first quarter Form 10-Q filed on May 12, 2008.
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 or near historical levels, customer growth in the Company’s core regulated water utility business, additional growth in revenues attributable to non-water sales operations, and the timing and adequacy of rate relief when requested, from time to time, by our regulated water company.
The Company believes that these factors and those described in detail in “Commitments and Contingencies” in Item 7 of its Annual Report on Form 10-K may have significant impact, either alone or in the aggregate, on the Company’s earnings and profitability in fiscal years 2008 and beyond. Please also review carefully the risks and uncertainties described below under the heading “Forward-Looking Information.”
Based on the Company’s current projections, the Company believes that its Net Income for the year 2008 will increase from the levels reported for 2007, primarily as a result of the second phase of Connecticut Water’s rate increase that was approved by the DPUC effective April 1, 2008. During 2008 and subsequent years, the ability of the Company to maintain and increase its Net Income will principally depend upon the effect on the Company of the factors described above in this “Outlook” section, those factors described in the section entitled “Commitments and Contingencies” in Item 7 of the Company’s Annual Report on Form 10-K and the risks and uncertainties described in “Forward-Looking Information” sections 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.
As of June 30, 2008, the Company had approximately $8.4 million in restricted cash related to the issuance of the 2007 A Series Revenue Bonds, due 2037. This amount represents cash that has not yet been spent on approved projects as part of the issuance of the debt in December 2007. The Company expects to spend all of the restricted cash on approved projects by the end of 2008.
Interim Bank Loans Payable at June 30, 2008 were approximately $14.2 million. The Company currently maintains an aggregate of $21 million in lines of credit with three banks. During 2007, the Company increased these lines because of expected increased construction spending and recently completed acquisitions. The lines of credit have lives that range from 12 to 29 months, which expire throughout 2008 and 2009. We expect to renew the lines as they expire. Interest expense charged on interim bank loans will fluctuate based on market interest rates.
The Company offers a dividend reinvestment plan (DRIP) to all shareholders, whereby shareholders can opt to have dividends directly reinvested into additional shares of the Company.
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
During the six months ended June 30, 2008 and 2007, the shareholders reinvested $484,000 and $496,000, respectively, as part of the DRIP.
From 1999 through 2003, the Company issued stock options to certain employees of the Company. No stock options have been issued by the Company since 2003. During the six months ended June 30, 2008, 6,059 options were exercised resulting in approximately $90,000 in proceeds to the Company. No stock options were exercised in the six months ended June 30, 2007.
Results of Operations
Three Months Ended June 30
Net Income for the three months ended June 30, 2008 increased from that of the prior year by $1,089,000, which increased earnings per basic and diluted average common share by $0.13, to $0.35.
This increase in Net Income is broken down by business segment as follows:
| Business Segment | | June 30, 2008 | | | June 30, 2007 | | | Increase/(Decrease) | |
| Water Activities | | $ | 2,747,000 | | | $ | 1,681,000 | | | $ | 1,066,000 | |
| Real Estate Transactions | | | -- | | | | -- | | | | -- | |
| Services and Rentals | | | 204,000 | | | | 181,000 | | | | 23,000 | |
| Total | | $ | 2,951,000 | | | $ | 1,862,000 | | | $ | 1,089,000 | |
The increase in the Water Activity segment’s Net Income was primarily due to the net effects of variances listed below:
| - | An increase of approximately $1,574,000 in Operating Revenue primarily due to new rates approved by the DPUC that became effective on April 1, 2008 and the acquisition of Eastern in January 2008, partially off-set by a decrease in per-customer consumption. The largest component of the increase in Operating Revenue was an increase of $268,000 in revenue from residential customers. Additionally, the Company received approximately $144,000 in payments from the South Central Regional Water Authority. In addition to these residential revenue increases, there were minor increases from commercial, industrial and public authority customers, due primarily to the rate increase effective April 1, 2008. |
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
| - | Operation and Maintenance expense increased by $350,000 primarily due to the following components: |
| Expense Components | | June 30, 2008 | | | June 30, 2007 | | | Increase/(Decrease) | |
| Labor | | $ | 3,058,000 | | | $ | 2,786,000 | | | $ | 272,000 | |
| Customer | | | 249,000 | | | | 175,000 | | | | 74,000 | |
| Outside Services | | | 327,000 | | | | 256,000 | | | | 71,000 | |
| Investor Relations | | | 205,000 | | | | 134,000 | | | | 71,000 | |
| Utility costs | | | 859,000 | | | | 789,000 | | | | 70,000 | |
| Water treatment (including chemical costs) | | | 453,000 | | | | 406,000 | | | | 47,000 | |
| Subscriptions & dues | | | 52,000 | | | | 12,000 | | | | 40,000 | |
| Purchased water | | | 281,000 | | | | 452,000 | | | | (171,000 | ) |
| Employee benefit costs | | | 1,043,000 | | | | 1,241,000 | | | | (198,000 | ) |
| Other | | | 1,496,000 | | | | 1,422,000 | | | | 74,000 | |
| Total | | $ | 8,023,000 | | | $ | 7,673,000 | | | $ | 350,000 | |
| - | Labor and employee benefit costs increased in 2008 by a net $74,000 due to an increase in employee levels due to the Eastern acquisition, regular wage increases effective as of April 1, 2008 and higher medical costs associated with the Company’s health and welfare plan, partially off-set by pension, post-retirement medical and other benefit cost decreases. Customer costs increased over the prior year period primarily due to an increase in uncollectible accounts. Outside services have increased primarily due to audit and information technology consulting fees, partially off-set by lower legal costs. The Company saw an increase in investor relations costs primarily due to the timing of the distribution of the 2007 annual report when compared to the distribution of the 2006 annual report. Utility costs have increased despite the Company’s efforts to lock in lower negotiated rates from energy suppliers due to higher electric costs in the state. The decrease in purchased water costs stemmed from a negotiated reduction in the Company’s purchased water rate from a neighboring water utility. |
| - | An increase in operating income tax expense of $200,000 primarily due to higher pretax income partially off-set by a lower effective income tax rate. This lower rate is due primarily to the effect of the planned pension contribution in 2008 exceeding the expected SFAS 87 pension expense. |
Six Months Ended June 30
Net Income for the six months ended June 30, 2008 increased from that of the prior year by $1,319,000, which increased earnings per basic and diluted average common share by $0.15, to $0.55.
This increase in Net Income is broken down by business segment as follows:
| Business Segment | | June 30, 2008 | | | June 30, 2007 | | | Increase/(Decrease) | |
| Water Activities | | $ | 4,262,000 | | | $ | 2,973,000 | | | $ | 1,289,000 | |
| Real Estate Transactions | | | -- | | | | 41,000 | | | | (41,000 | ) |
| Services and Rentals | | | 394,000 | | | | 323,000 | | | | 71,000 | |
| Total | | $ | 4,656,000 | | | $ | 3,337,000 | | | $ | 1,319,000 | |
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
The increase in the Water Activity segment’s Net Income was primarily due to the net effects of variances listed below:
| - | An increase of approximately $1,981,000 in Operating Revenue primarily due to the acquisition of Eastern in January 2008 and new rates approved by the DPUC that became effective on April 1, 2008, partially off-set by a decrease in per-customer consumption. The largest component of the increase in Operating Revenue was an increase of $450,000 in revenue from residential customers. Additionally, the Company received approximately $250,000 in payments from the South Central Regional Water Authority. In addition to these residential revenue increases, there were minor increases from commercial, industrial and public authority customers, due primarily to the rate increase effective April1, 2008. |
| - | Operation and Maintenance expense increased by $394,000 primarily due to the following components: |
| Expense Components | | June 30, 2008 | | | June 30, 2007 | | | Increase/(Decrease) | |
| Labor | | $ | 5,813,000 | | | $ | 5,396,000 | | | $ | 417,000 | |
| Customer | | | 467,000 | | | | 307,000 | | | | 160,000 | |
| Outside services | | | 652,000 | | | | 577,000 | | | | 75,000 | |
| Water treatment (including chemical costs) | | | 855,000 | | | | 784,000 | | | | 71,000 | |
| Utility costs | | | 1,717,000 | | | | 1,676,000 | | | | 41,000 | |
| Maintenance | | | 747,000 | | | | 782,000 | | | | (35,000 | ) |
| Employee benefit costs | | | 2,353,000 | | | | 2,403,000 | | | | (50,000 | ) |
| Purchased water | | | 303,000 | | | | 605,000 | | | | (302,000 | ) |
| Other | | | 2,314,000 | | | | 2,297,000 | | | | 17,000 | |
| Total | | $ | 15,221,000 | | | $ | 14,827,000 | | | $ | 394,000 | |
| - | Labor and employee benefit costs increased in 2008 by a net $367,000 due to an increase in employee levels due to the Eastern acquisition, regular wage increases effective as of April 1, 2008 and higher medical costs associated with the Company’s health and welfare plan. These increases in Labor and employee benefit costs were partially off-set due to reduced pension costs and post-retirement medical costs. Customer costs increased over the prior year primarily due to an increase in uncollectible accounts. Outside services have increased primarily due to audit and information technology consulting fees, partially off-set by lower legal costs. The decrease in purchased water costs stemmed from a negotiated reduction in the Company’s purchased water rate from a neighboring water utility. |
| - | An increase in operating income tax expense of $144,000 primarily due to higher pretax income partially off-set by a lower effective income tax rate. This lower rate is due primarily to the effect of the planned pension contribution in 2008 exceeding the expected SFAS 87 pension expense. |
Commitments and Contingencies
There were no material changes under this subheading to any of the other items previously disclosed by the Company in its Annual Report on Form 10-K for the period ended December 31, 2007.
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
19 Perry Street Litigation
Connecticut Water’s Unionville division has for many years operated a well field located at 19 Perry Street, Farmington, Connecticut, pursuant to a 99-year lease entered into in 1975 with the property owner. This well field provides approximately half of the daily water supply requirements to the customers of the Unionville division. In 2004, the original property owner ceased business operations. The property is now owned by 19 Perry Street, LLC, which obtained the property through a foreclosure proceeding. In June 2007, the new owner commenced a lawsuit in Hartford Superior Court (Housing Section), asserting that Connecticut Water is in unlawful possession of the property under several theories, including that the lease is invalid and that Connecticut Water has failed to pay rent when due. A trial before a judge was held in November 2007, and a decision was issued on April 30, 2008. In its decision, the Court ruled that the lease is valid. However, in deciding the parties’ contentions regarding the proper form and amount of rental payments due, the Court ruled that Connecticut Water was in breach of its obligation to pay rent on the property and therefore entered an order of eviction.
On May 5, 2008, Connecticut Water filed a timely appeal of the decision in the Connecticut Appellate Court. This appeal stays the eviction order until the Appellate Court rules on Connecticut Water’s claims that the trial court erred. At this time, the outcome of the appeal is uncertain. On August 5, 2008, Connecticut Water was served with a related lawsuit in which 19 Perry Street, LLC seeks the payment of back rent with respect to the property. The Company intends to maintain its use of the property to provide water to customers of its Unionville division while the appeal is pending. In addition, Connecticut Water will consider all other options with respect to its well field use of the property, including (i) negotiations with the property owner for a new lease agreement, (ii) the outright purchase of the property or (iii) the exercise of Connecticut Water’s right to take the property by initiating eminent domain proceedings under applicable law.
Forward-Looking Information
This report, including management’s discussion and analysis, contains certain forward-looking statements regarding the Company’s results of operations and financial position. These forward-looking statements are based on current information and expectations, and are subject to risks and uncertainties, which could cause the Company’s actual results to differ materially from expected results.
Regulated water companies, including The Connecticut Water Company, are subject to various federal and state regulatory agencies concerning water quality and environmental standards. Generally, the water industry is materially dependent on the adequacy of approved rates to allow for a fair rate of return on the investment in utility plant. The ability to maintain our operating costs at the lowest possible level, while providing good quality water service, is beneficial to customers and stockholders. Profitability is also dependent on the timeliness of rate relief to be sought from, and granted by, the DPUC, when necessary, and numerous factors over which we have little or no control, such as the quantity of rainfall and temperature, customer demand and related conservation efforts, financing costs, energy rates, tax rates, and stock market trends which may affect the return earned on pension assets, compliance with environmental and water quality regulations and the outcome of litigation matters, including the Unionville division well field dispute. From time to time, the Company may acquire other regulated and/or unregulated water companies. Profitability on these acquisitions is often dependent on the successful integration of these companies, including the January 2008 acquisition of Eastern Connecticut Regional Water Company, Inc. and Birmingham H20 Services Inc. The profitability of our other revenue sources is subject to the amount of land we have available for sale and/or donation, the demand for the land, the continuation of the current state tax benefits relating to the donation of land for open space purposes, regulatory approval of land dispositions, the demand for telecommunications antenna site leases, and the successful extensions and expansion of our service contract work. We undertake no obligation to update or revise forward-looking statements, whether as a result of new information, future events, or otherwise.
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
Part I, Item 3: Quantitative and Qualitative Disclosure About Market Risk
The primary market risk faced by the Company is interest rate risk. The Company has exposure to derivative financial instruments through an interest rate swap agreement. The Company has no other financial instruments with significant credit risk or off-balance sheet risks and is not subject, in any material respect, to any currency or other commodity risk.
The Company is subject to the risk of fluctuating interest rates in the normal course of business. The Company’s exposure to interest fluctuations is managed at the Company and subsidiary operations levels through the use of a combination of fixed rate long-term debt, variable long-term debt and short-term variable borrowings under financing arrangements entered into by the Company and its subsidiaries and its use of the interest rate swap agreement discussed below. The Company has $21.0 million of variable rate lines of credit with three banks, under which the interim bank loans payable at June 30, 2008 were approximately $14.2 million.
During March 2004, The Connecticut Water Company entered into a five-year interest rate swap transaction in connection with the refunding of its First Mortgage Bonds (Series V). The swap agreement provides for The Connecticut Water Company’s exchange of floating rate interest payment obligations for fixed rate interest payment obligations on a notional principal amount of $12.5 million. The purpose of the interest rate swap is to manage the Company’s exposure to fluctuations in prevailing interest rates. The Company does not enter into derivative financial contracts for trading or speculative purposes and does not use leveraged instruments.
As of June 30, 2008, the Company had $22.05 million of variable-rate debt outstanding, of which $12.5 million have been fixed by operation of the interest rate swap described above. Holding other variables constant, including levels of indebtedness, a one-percentage point change in interest rates would impact pre-tax earnings by approximately $0.1 million.
Although there can be no assurances that interest rates will not significantly change during the next twelve months, management does not believe that changes in interest rates will have a material effect on income or cash flow.
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, management, including the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e)). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports the Company files and submits under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
Changes in Internal Control Over Financial Reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Because of its inherent limitation, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.
We are involved in various legal proceedings from time to time. Although the results of legal proceedings cannot be predicted with certainty, there are no pending legal proceedings to which we or any of our subsidiaries are a party or to which any of our properties is the subject that presents a reasonable likelihood of a material adverse impact on the Company. Certain other legal proceedings that relate to specific segments of the Company’s business are discussed in Item 2, Part I, of this Form 10-Q under the heading “Commitments and Contingencies”.
Information regarding risk factors appeared in Item 1A of Part I of our Report on Form 10-K for the fiscal year ended December 31, 2007. There have been no material changes to our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007.
Part II, Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
No stock repurchases were made during the quarter ended June 30, 2008.
On May 15, 2008, at its annual meeting, the stockholders of Connecticut Water Service, Inc. elected the following directors to serve three-year terms expiring at the annual meeting to be held in 2011 by the following votes:
| | | For | | | Withheld | |
| Mary Ann Hanley | | | 20,241,457 | | | | 446,289 | |
| Mark G. Karchur | | | 20,221,827 | | | | 465,919 | |
| David A. Lentini | | | 20,211,497 | | | | 476,249 | |
Directors whose term of office continues until the 2009 annual meeting are Lisa J. Thibdaue, Carol P. Wallace, and Donald B. Wilbur.
Directors whose term of office continues until the 2010 annual meeting are Heather Hunt, Arthur C. Reeds, and Eric W. Thornburg.
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
The appointment of PricewaterhouseCoopers, LLP, as the independent registered public accounting firm for the Company for the fiscal year ending December 31, 2008 was ratified by the stockholders by the following vote:
| | | For | | | Withheld | | | Abstain | |
| PricewaterhouseCoopers, LLP | | | 20,417,894 | | | | 183,696 | | | | 86,156 | |
Exhibit Number | | Description |
| | | |
| 3.1 | | Certificate of Incorporation of Connecticut Water Service, Inc. amended and restated as of April, 1998. (Exhibit 3.1 to Form 10-K for the year ended 12/31/98). |
| | | |
| 3.2 | | By Laws, as amended, of Connecticut Water Service, Inc. as amended and restated as of August 12, 1999. (Exhibit 3.2 to Form 10-K for the year ended 12/31/99). |
| | | |
| 3.3 | | Certification of Incorporation of The Connecticut Water Company effective April, 1998. (Exhibit 3.3 to Form 10-K for the year ended 12/31/98). |
| | | |
| 3.4 | | Certificate of Amendment to the Certificate of Incorporation of Connecticut Water Service, Inc. dated August 6, 2001 (Exhibit 3.4 to Form 10-K for the year ended 12/31/01). |
| | | |
| 3.5 | | Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Connecticut Water Service, Inc. dated April 23, 2004. (Exhibit 3.5 to Form 10-Q for the quarter ended March 31, 2003). |
| | | |
| 10.1* | | Stock Purchase Agreement, dated July 21, 2008, between The Connecticut Water Company, Ellington Acres Company, and the shareholders of EAC. |
| | | |
| 31.1* | | Rule 13a-14 Certification of Eric W. Thornburg, Chief Executive Officer. |
| | | |
| 31.2* | | Rule 13a-14 Certification of David C. Benoit, Chief Financial Officer. |
| | | |
| 32* | | Certification of Eric W. Thornburg, Chief Executive Officer, and David C. Benoit, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | | |
| * filed herewith |
CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | Connecticut Water Service, Inc. (Registrant) |
| Date: August 8, 2008 | By: /s/ David C. Benoit David C. Benoit Vice President – Finance and Chief Financial Officer |
| Date: August 8, 2008 | By: /s/ Nicholas A. Rinaldi Nicholas A. Rinaldi Controller |
