1 SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED June 30, 1999 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 06-0739839 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 93 West Main Street, Clinton, CT 06413-1600 (Address of principal executive offices) (Zip Code) (860) 669-8636 (Registrant's telephone number, including area code) Not Applicable (Former name, 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 ------- -------- APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a count. Yes No ------- -------- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 4,594,815 Number of shares of common stock outstanding, June 30, 1999 2 CONNECTICUT WATER SERVICE, INC. Financial Report June 30, 1999 and 1998 TABLE OF CONTENTS PART I, ITEM 1: FINANCIAL STATEMENTS Consolidated Balance Sheets at June 30, 1999 and December 31, 1998 Page 3 Consolidated Statements of Capitalization at June 30, 1999 and December 31, 1998 Page 4 Consolidated Statements of Income for Three Months Ended June 30, 1999 and 1998 Page 5 Consolidated Statements of Income for Six Months Ended June 30, 1999 and 1998 Page 6 Consolidated Statements of Income for Twelve Months Ended June 30, 1999 and 1998 Page 7 Consolidated Statements of Retained Earnings for Three Months Ended June 30, 1999 and 1998 Page 8 Consolidated Statements of Retained Earnings for Six Months Ended June 30, 1999 and 1998 Page 8 Consolidated Statements of Retained Earnings for Twelve Months Ended June 30, 1999 and 1998 Page 8 Consolidated Statements of Cash Flows for Six Months Ended June 30, 1999 and 1998 Page 9 Notes to Consolidated Financial Statements Page 10 PART I, ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations Page 13-15 Signature Page Page 16 3 Page 3 CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS At June 30, 1999 and December 31, 1998 (In thousands) JUNE 30, 1999 DEC. 31, ASSETS (UNAUDITED) 1998 ----------- --------- Utility Plant Utility Plant $ 224,650 $ 222,411 Construction Work in Progress 5,395 4,459 Utility Plant Acquisition Adjustments (1,253) (1,253) --------- --------- 228,792 225,617 Accumulated Provision for Depreciation (59,062) (56,913) --------- --------- Net Utility Plant 169,730 168,704 --------- --------- Investments 2,163 2,110 --------- --------- Current Assets Cash 1,170 128 Accounts Receivable (Less Allowance, 1999- $270; 1998 - $207) 7,486 7,754 Prepayments and Other Current Assets 841 877 --------- --------- Total Current Assets 9,497 8,759 --------- --------- Deferred Charges and Regulatory Assets Unamortized Debt Issuance Expense 5,763 5,896 Income Taxes 9,053 9,000 Postretirement Benefits Other Than Pension 1,150 1,150 Other Costs 1,159 971 --------- --------- Total Deferred Charges 17,125 17,017 --------- --------- TOTAL ASSETS $ 198,515 $ 196,590 ========= ========= CAPITALIZATION AND LIABILITIES Capitalization (See accompanying statements) Common Stockholders' Equity $ 59,149 $ 58,502 Preferred Stock 772 772 Long-Term Debt 62,614 62,634 --------- --------- Total Capitalization 122,535 121,908 --------- --------- Current Liabilities Current Portion Long Term Debt 43 297 Interim Bank Loans Payable 4,546 1,895 Accounts Payable and Accrued Taxes and Interest 5,798 7,809 Other 2,582 2,442 --------- --------- Total Current Liabilities 12,969 12,443 --------- --------- Long-Term Liabilities Advances for Construction 15,515 15,195 Contributions in Aid of Construction 20,311 20,316 Deferred Federal Income Taxes 15,524 15,038 Unfunded Future Income Taxes 8,500 8,500 Unfunded Postretirement Benefits Other Than Pension 1,150 1,150 Unamortized Investment Tax Credits 2,011 2,040 --------- --------- Total Long-Term Liabilities 63,011 62,239 --------- --------- TOTAL CAPITALIZATION AND LIABILITIES $ 198,515 $ 196,590 ========= ========= The accompanying notes are an integral part of these financial statements. 4 Page 4 CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CAPITALIZATION At June 30, 1999 and December 31, 1998 (In thousands, except share data) JUNE 30, 1999 DEC. 31, (UNAUDITED) 1998 ----------- --------- Common Stockholders' Equity Common Stock Without Par Value; Authorized - 7,500,000 Shares; Shares Issued and Outstanding: 1999 - 4,594,815; 1998 - 4,583,616 $ 44,677 $ 44,590 Stock Issuance Expense (1,385) (1,385) Retained Earnings 15,857 15,297 --------- --------- Total Common Stockholders' Equity 59,149 58,502 --------- --------- Cumulative Preferred Stock of Connecticut Water Service, Inc. Series A Voting, $20 Par Value; Authorized, Issued and Outstanding 15,000 Shares, Redeemable at $21.00 Per Share 300 300 Series $.90 Non-Voting, $16 Par Value; Authorized 50,000 Shares Issued and Outstanding 29,499 Shares, Redeemable at $16.00 Per Share 472 472 --------- --------- Total Preferred Stock of Connecticut Water Service, Inc. 772 772 --------- --------- Long-Term Debt The Connecticut Water Company First Mortgage Bonds 5.875% Series R, due 2022 14,800 14,800 6.65% Series S, due 2020 8,000 8,000 5.75% Series T, due 2028 5,000 5,000 5.3% Series U, due 2028 4,550 4,550 6.94% Series V, due 2029 12,050 12,050 --------- --------- 44,400 44,400 --------- --------- Unsecured Water Facilities Revenue Refinancing Bonds 5.05% 1998 Series A, due 2028 10,000 10,000 5.125% 1998 Series B, due 2028 8,000 8,000 --------- --------- 18,000 18,000 --------- --------- Other 5.5% Unsecured Promissory Note 116 132 --------- --------- 62,516 62,532 Gallup Water Service 9.58% Due 1999 0 255 --------- --------- 0 255 --------- --------- Chester Realty 6% Due 2006 141 144 --------- --------- 141 144 --------- --------- TOTAL 62,657 62,931 --------- --------- Less Current Portion of Long-Term Debt (43) (297) --------- --------- Total Long-Term Debt 62,614 62,634 --------- --------- TOTAL CAPITALIZATION $ 122,535 $ 121,908 ========= ========= The accompanying notes are an integral part of these financial statements. 5 Page 5 CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME For the Three Months Ended June 30, 1999 and 1998 (In thousands, except share data) 1999 1998 (UNAUDITED) (UNAUDITED) ----------- ----------- Operating Revenues $ 9,766 $ 8,942 ------- ------- Operating Expenses Operation and Maintenance 3,997 4,178 Depreciation 1,041 947 Federal and State Income Taxes 1,080 549 Municipal Taxes 862 870 Payroll Taxes 115 132 ------- ------- Total Operating Expenses 7,095 6,676 ------- ------- Utility Operating Income 2,671 2,266 ------- ------- Other Income (Deductions) Interest 1 31 Allowance for Funds Used During Construction 113 119 Gain on Sale of Property 36 207 Non-Water Sales Earnings 63 57 Miscellaneous Income (Deductions) (2) (8) Taxes on Other Income (28) (103) ------- ------- Total Other Income (Deductions) 183 303 ------- ------- Interest and Debt Expense Interest on Long-Term Debt 928 931 Other Interest Charges 71 89 Amortization of Debt Expense 79 54 ------- ------- Total Interest and Debt Expense 1,078 1,074 ------- ------- Net Income Before Preferred Dividends 1,776 1,495 Preferred Stock Dividend Requirement 9 9 ------- ------- Net Income Applicable to Common Stockholders $ 1,767 $ 1,486 ======= ======= Weighted Average Common Shares Outstanding 4,595 4,583 ======= ======= Basic and Fully Diluted Earnings Per Average Common Share $ 0.38 $ 0.32 ======= ======= Dividends Per Common Share $0.2925 $0.2865 ======= ======= The accompanying notes are an integral part of these financial statements. 6 Page 6 CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME For the Six Months Ended June 30, 1999 and 1998 (In thousands, except share data) 1999 1998 (UNAUDITED) (UNAUDITED) ----------- ----------- Operating Revenues $ 18,767 $ 17,750 -------- -------- Operating Expenses Operation and Maintenance 7,881 7,854 Depreciation 2,091 1,895 Federal and State Income Taxes 1,789 1,418 Municipal Taxes 1,727 1,685 Payroll Taxes 285 307 -------- -------- Total Operating Expenses 13,773 13,159 -------- -------- Utility Operating Income 4,994 4,591 -------- -------- Other Income (Deductions) Interest 59 55 Allowance for Funds Used During Construction 232 249 Gain on Sale of Property 41 207 Non-Water Sales Earnings 98 85 Miscellaneous Income (Deductions) (4) (11) Taxes on Other Income (40) (120) -------- -------- Total Other Income (Deductions) 386 465 -------- -------- Interest and Debt Expense Interest on Long-Term Debt 1,856 1,806 Other Interest Charges 138 251 Amortization of Debt Expense 133 102 -------- -------- Total Interest and Debt Expense 2,127 2,159 -------- -------- Net Income Before Preferred Stock 3,253 2,897 Preferred Stock Dividend Requirement 19 19 -------- -------- Net Income Applicable to Common Stockholders $ 3,234 $ 2,878 ======== ======== Weighted Average Common Shares Outstanding 4,591 4,582 ======== ======== Basic and Fully Diluted Earnings Per Average Common Share $ 0.70 $ 0.63 ======== ======== Dividends Per Common Share $ 0.5824 $ 0.5731 ======== ======== The accompanying notes are an integral part of these financial statements. 7 Page 7 CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME For the Twelve Months Ended June 30, 1999 and 1998 (In thousands, except share data) 1999 1998 (UNAUDITED) (UNAUDITED) ----------- ----------- Operating Revenues $ 39,524 $ 37,911 -------- -------- Operating Expenses Operation and Maintenance 16,234 15,566 Depreciation 4,096 3,684 Federal and State Income Taxes 4,397 4,123 Municipal Taxes 3,498 3,336 Payroll Taxes 495 548 -------- -------- Total Operating Expenses 28,720 27,257 -------- -------- Utility Operating Income 10,804 10,654 -------- -------- Other Income (Deductions) Interest 144 129 Allowance for Funds Used During Construction 459 510 Gain on Sale of Property 309 220 Non-Water Sales Earnings 201 178 Miscellaneous Income (Deductions) (30) (72) Taxes on Other Income (182) (162) -------- -------- Total Other Income (Deductions) 901 803 -------- -------- Interest and Debt Expense Interest on Long-Term Debt 3,714 3,553 Other Interest Charges 359 645 Amortization of Debt Expense 242 197 -------- -------- Total Interest and Debt Expense 4,315 4,395 -------- -------- Net Income Before Preferred Dividend 7,390 7,062 Preferred Stock Dividend Requirement 38 38 -------- -------- Net Income Applicable to Common Stockholders $ 7,352 $ 7,024 ======== ======== Weighted Average Common Shares Outstanding 4,587 4,578 ======== ======== Basic and Fully Diluted Earnings Per Average Common Share $ 1.60 $ 1.53 ======== ======== Dividends Per Common Share $ 1.1620 $ 1.1466 ======== ======== The accompanying notes are an integral part of these financial statements. 8 Page 8 CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (In thousands, except share data) For the Three Months Ended June 30, 1999 and 1998 1999 1998 (UNAUDITED) (UNAUDITED) ----------- ----------- Balance at Beginning of Period $15,434 $13,662 Net Income 1,776 1,495 ------- ------- 17,210 15,157 ------- ------- Dividends Declared: Cumulative Preferred, Class A, $.20 per share 3 3 Cumulative Preferred, Series $.90, $.225 per share 6 6 Common Stock - 1999 $0.2925 per share; 1998 $0.2865 per share 1,344 1,313 ------- ------- 1,353 1,322 ------- ------- Balance at End of Period $15,857 $13,835 ======= ======= FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 Balance at Beginning of Period $15,297 $13,583 Net Income 3,253 2,897 ------- ------- 18,550 16,480 ------- ------- Dividends Declared: Cumulative Preferred, Class A, $.40 per share 6 6 Cumulative Preferred, Series $.90, $.45 per share 13 13 Common Stock - 1999 $0.5824 per share; 1998 $0.5731 per share 2,674 2,626 ------- ------- 2,693 2,645 ------- ------- Balance at End of Period $15,857 $13,835 ======= ======= FOR THE TWELVE MONTHS ENDED JUNE 30, 1999 AND 1998 Balance at Beginning of Period $13,835 $12,060 Net Income 7,390 7,062 ------- ------- 21,225 19,122 ------- ------- Dividends Declared: Cumulative Preferred, Class A, $.80 per share 12 12 Cumulative Preferred, Series $.90, $.90 per share 26 26 Common Stock - 1999 $1.1620 per share; 1998 $1.1466 per share 5,330 5,249 ------- ------- 5,368 5,287 ------- ------- Balance at End of Period $15,857 $13,835 ======= ======= The accompanying notes are an integral part of these financial statements. 9 Page 9 CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS For the Six Months Ended June 30, 1999 and 1998 (In thousands) 1999 1998 (UNAUDITED) (UNAUDITED) ----------- ----------- Operating Activities: Net Income Before Preferred Dividends $ 3,253 $ 2,897 -------- -------- Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Depreciation (including $61 in 1999, $63 in 1998 charged to other accounts) 2,152 1,958 Change in Assets and Liabilities: (Increase) Decrease in Accounts Receivable and Accrued Unbilled Revenues 268 (557) (Increase) Decrease in Other Current Assets 36 59 (Increase) Decrease in Other Non-Current Items (160) (327) Increase (Decrease) in Accounts Payable, Accrued Expenses and Other Current Liabilities (1,913) (1,935) Increase (Decrease) in Deferred Federal Income Taxes and Investment Tax Credits, Net 457 477 -------- -------- Total Adjustments 840 (325) -------- -------- Net Cash Provided by (Used for) Operating Activities 4,093 2,572 -------- -------- Investing Activities: Gross Additions to Utility Plant (including Allowance for Funds Used During Construction of $232 in 1999 and $249 in 1998) (3,180) (3,031) -------- -------- Financing Activities: Proceeds from Interim Bank Loans 4,546 4,129 Repayment of Interim Bank Loans (1,895) (8,811) Proceeds from Issuance of Common Stock 87 93 Net Proceeds from Issuance of Long-Term Debt 0 18,000 Repayment of Long-Term Debt (232) (10,030) Advances, Contributions and Funds From Others for Construction, Net 317 472 Costs Incurred to Issue Long-Term Debt, Preferred Stock, and Common Stock (1) (1,098) Cash Dividends Paid (2,693) (2,645) -------- -------- Net Cash Provided by (Used for) Financing Activities 129 110 -------- -------- Net Increase (Decrease) in Cash 1,042 (349) Cash at Beginning of Year 128 447 -------- -------- Cash at End of Period $ 1,170 $ 98 ======== ======== Supplemental Disclosures of Cash Flow Information: Cash Paid During the Year for: Interest (Net of Amounts Capitalized) $ 1,986 $ 2,476 Income Taxes $ 1,770 $ 1,795 The accompanying notes are an integral part of these financial statements. 10 Page 10 CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. The consolidated financial statements included herein have been prepared by CONNECTICUT WATER SERVICE, INC. (the Company), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission and reflect all adjustments 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. 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 10-K. 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. 2. On April 16, 1999 Gallup Water Service, Inc. ("Gallup") was merged with and into the Company through the issuance of 47,826 shares of Connecticut Water Service, Inc. which were exchanged for substantially all of the outstanding common shares of Gallup. The merger has been accounted for as a pooling-of-interests. Accordingly, the Company's financial statements have been restated to include the results of Gallup for all periods presented. The combined and separate results of the Company and Gallup during the periods preceding and after the merger were as follows: (In thousands of Dollars) June 30 ------------------------------------------- Three Months Six Months Twelve Months Ended Ended Ended ------------ ---------- ------------- Operating Revenues 1999 Connecticut Water Service Consolidated $ 9,621 $18,479 $38,935 Gallup Water Service, Inc. 145 288 589 ------- ------- ------- Combined $ 9,766 $18,767 $39,524 ------- ======= ======= 1998 Connecticut Water Service Consolidated $ 8,796 $17,468 $37,324 Gallup Water Service, Inc. 146 282 587 ------- ------- ------- Combined $ 8,942 $17,750 $37,911 ======= ======= ======= 11 Page 11 CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARY June 30 ------------------------------------------- Three Months Six Months Twelve Months Ended Ended Ended ------------ ---------- ------------- Net Income Applicable to Common Stockholders 1999 Connecticut Water Service Consolidated $ 1,790 $ 3,242 $ 7,319 Gallup Water Service, Inc. (23) (8) 33 ------- ------- ------- Combined $ 1,767 $ 3,234 $ 7,352 ======= ======= ======= 1998 Connecticut Water Service Consolidated $ 1,470 $ 2,850 $ 6,977 Gallup Water Service, Inc. 16 28 47 ------- ------- ------- Combined $ 1,486 $ 2,878 $ 7,024 ======= ======= ======= 3. Earnings per average common share are calculated by dividing net income applicable to common stock by the average number of shares of common stock outstanding during the respective periods as detailed on the following page: 12 Page 12 CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARY 3 Months Ended 12 Months Ended ------------------------ ---------------------------------------- 6/30/99 6/30/98 6/30/99 6/30/98 12/31/98 --------- --------- --------- --------- --------- Common Shares Outstanding: January 1, 1998 -- -- -- -- 4,575,462 July 1, 1998 & 1997 respectively -- 4,583,616 4,573,478 -- April 1, 1999 & 1998 respectively 4,594,676 4,583,075 -- -- -- Common Shares Issued: To CSE - September 15, 1997 -- -- -- 61 -- To 401-K - September 30, 1997 -- -- -- 1,002 -- To CSE - December 15, 1997 -- -- -- 57 -- To 401-K - December 31, 1997 -- -- -- 864 -- To PSP - February 18, 1998 -- -- -- 6,921 6,921 To CSE - March 15, 1998 -- -- -- 102 102 To 401-K - March 30, 1998 -- -- -- 590 590 To CSE - June 15, 1998 -- 95 -- 95 95 To 401-K - June 30, 1998 -- 446 -- 446 446 Liquidation of Fractional Shares -- -- (587) -- (587) To CSE - September 15, 1998 -- -- 82 -- 82 To 401-K - September 30, 1998 -- -- 528 -- 528 To CSE - December 15, 1998 -- -- 81 -- 81 To 401-K - December 31, 1998 -- -- 391 -- 391 To PSP - March 1, 1999 -- -- 10,418 -- -- To CSE - March 15, 1999 -- -- 147 -- -- To CSE - June 15, 1999 139 -- 139 -- -- ---------- ---------- ---------- ---------- ---------- Common Shares Outstanding: June 30, 1999 & 1998 respectively 4,594,815 4,583,616 4,594,815 4,583,616 ========== ========== ========== ========== December 31, 1998 4,584,111 ========= Weighted Average Common Shares Outstanding: Days outstanding basis* 4,594,700 4,583,097 4,587,387 4,578,150 4,582,976 ========== ========== ========== ========== ========== * Basic and Fully diluted are the same. The share amounts above have been restated by 47,826 shares due to the pooling of interest required for the Gallup Water Service, Inc. acquisition. PSP = Performance Stock Program 401-K = Company contribution to employees' 401-K savings plan CSE = Common Stock Equivalents 13 Page 13 CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARY PART I, ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LIQUIDITY AND CORPORATE RESOURCES At June 30, 1999 the Company had $4,454,000 of unused lines of interim bank loan credit available. RESULT OF OPERATIONS THE FOLLOWING FACTORS HAD A SIGNIFICANT EFFECT UPON THE COMPANY'S NET INCOME FOR THE THREE MONTHS ENDED JUNE 30, 1999 AS COMPARED WITH THE NET INCOME FOR THE SAME PERIOD LAST YEAR. Net income applicable to common stock for the three months ended June 30, 1999 increased from that of June 30, 1998 by $281,000, or $.06, per average common share. The increase in net income resulted from a $405,000 increase in operating income, partially offset by a $120,000 decrease in other income and deductions and a $4,000 increase in interest and debt expense. The increase in operating income is due to a 9.2% increase in operating revenues, partially offset by a 6.3% increase in operating expenses. The increase in operating revenues is a result of higher than average customer water consumption due to the dry, hot weather in June 1999. The increase in operating expenses is primarily due to increased income taxes as a result of the higher taxable income. The decrease in other income and deductions is primarily due to a lower level of real estate land sales in 1999 as compared to 1998. THE FOLLOWING FACTORS HAD A SIGNIFICANT EFFECT UPON THE COMPANY'S NET INCOME FOR THE SIX MONTHS ENDED JUNE 30, 1999 AS COMPARED WITH THE NET INCOME FOR THE SAME PERIOD LAST YEAR. Net income applicable to common stock for the six months ended June 30, 1999 increased from that of June 30, 1998 by $356,000. The improvement in net income resulted from a $403,000 increase in operating income and $32,000 decrease in interest and debt expense, partially offset by a $79,000 decrease in other income. The 5.7% increase in operating revenues is primarily due to higher than average water consumption as a result of the dry, hot weather in June 1999. The 4.7% increase in operating expenses is primarily due to higher income taxes as a result of the higher taxable income and higher depreciation and municipal tax expense as a result of the Company's increasing investment in utility plant. The decrease in other income is primarily due to a lower level of real estate sales in 1999 as compared to 1998. 14 Page 14 CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARY YEAR 2000 Like many organizations, the Company has evaluated and continues to respond to its exposure to the Year 2000 problem. In general terms, the problem arises from the fact that many existing computer systems and other equipment containing date-sensitive embedded technology (including non-information technology equipment and systems) use only two digits to identify a year in the date field, with the assumption that the first two digits of the year are always "19". As a result, such systems may misinterpret dates after December 31, 1999, which may result in miscalculations, other malfunctions or the total failure of such systems. Additional problems arise from the fact that the Year 2000 is a special case leap year. Because the Company is dependent upon the proper functioning of computer systems and other equipment containing date-sensitive embedded technology, a failure of such systems and equipment to be Year 2000 compliant could have a material adverse effect on the Company. If not remedied, potential risks include business interruption or shutdown, financial loss, regulatory actions and legal liability. Last year the Company established a team of senior managers to address the Year 2000 problem. This team has evaluated the Company's exposure to the Year 2000 problem and has prepared, and is executing a plan for managing the risks and costs associated therewith. The DPUC has reviewed the readiness of nine utilities, of which the Company is one. The Company's general process of addressing the Year 2000 problem can be broken down into the following steps: (a) inventorying systems, equipment and other items (including those of third parties) that potentially present a Year 2000 problem, (b) assigning priorities to identified items, (c) assessing the Year 2000 compliance of the items determined to be material to the Company through internal testing and outside certification,(d) repairing or replacing items determined to be non-compliant, and (e) designing and implementing contingency plans around items that are identified to be subject to, a Year 2000 problem but unable to be tested or otherwise determined to be compliant. Since 1996, the Company has been implementing a new Management Information System (MIS) encompassing operational and administrative applications. In addition to enhanced customer service technology and increased administrative and operational efficiencies, the new system is certified to be Year 2000 compliant. The integration of the new system is now complete. The costs of implementing the new system totalled approximately $2 million, which the Company has capitalized. The Company has done internal testing of the MIS and has completed its Year 2000 testing of MIS. The Company has found no indication that the MIS is not Year 2000 compliant as certified by its software or hardware vendors. The Company also has evaluated the Year 2000 compliance of systems and equipment which are not linked to the MIS and has identified the items that could be impacted by the Year 2000 problem. Once the Company determined that an item may present a Year 2000 problem, the Company contacted the supplier to obtain adequate assurance that it is Year 2000 compliant or determined and addressed any non-compliance. In addition, wherever practical, the Company independently tested the item for compliance. The Company has obtained supplier compliance certification for substantially all of our items that it has inventoried as potentially non-compliant. The Company is in the process of all repairs and replacing non-compliant systems and equipment. It is currently 95% done with this stage and anticipates completion by October 1, 1999. 15 Page 15 In addition to its own systems and equipment, the Company depends upon the proper function of computer systems and other date-sensitive equipment of outside parties. These parties include other water companies, banks, telecommunications service providers and electric and other utilities. The Company has initiated communications with such parties to determine the extent to which they are vulnerable to the Year 2000 issue and, in certain circumstances, to coordinate joint testing. If the third parties with which the Company interacts have Year 2000 problems that are not remedied, resulting problems could include the loss of telecommunications and electrical service, the receipt of inaccurate financial and billing-related information, and the disruption of capital flows potentially resulting in liquidity stress. Due to the uncertainties presented by such third party Year 2000 problems, and the possibility that, despite its efforts, the Company is unsuccessful in preparing its internal systems and equipment for the Year 2000,the Company has prepared contingency plans for dealing with the most reasonably likely worst case scenario. Such plans include manual back-ups for crucial automated systems, the use of electrical generators capable of sustaining operations through a power failure, and enhanced transition-period staffing to compensate for automation and communication failures. The Company expects to have all contingency systems in place and fully tested by the third quarter of 1999. As the Company already has extensive disaster-contingency systems in place, it does not believe that the cost of preparing or effecting Year 2000 contingency plans will be material. The Company does not believe that the costs of addressing the Year 2000 problem, excluding the costs of the MIS, will be material to the Company's financial condition. The Company anticipates spending approximately $300,000 for affecting its Year 2000 program in 1999. The Company has funded, and expects to continue to fund, the costs of its Year 2000 efforts through its operating cash flow. The costs of the Company's Year 2000 program and the timetable for completing its Year 2000 preparations are based on current estimates, which reflect numerous assumptions about future events, including the continued availability of certain resources, the timing and effectiveness of third-party remediation plans and other factors. The Company can give no assurance that these estimates will be achieved, and actual results could differ materially from those currently anticipated. In addition, there can be no assurance that the Company's Year 2000 program will be effective or that its contingency plans will be sufficient. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct relevant computer software codes and embedded technology, the results of internal and external testing and the timeliness and effectiveness of remediation efforts of third parties. 16 Page 16 SIGNATURES 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 13, 1999 By /s/ David C. Benoit ------------------------ David C. Benoit Vice President - Finance Date: August 13, 1999 By: /s/ Peter J. Bancroft ------------------------ Peter J. Bancroft Assistant Treasurer