Attached files

file filename
EX-32 - SOX CERTIFICATION - CONNECTICUT WATER SERVICE INC / CTexhibit32q32016.htm
EX-31.2 - CFO CERTIFICATION - CONNECTICUT WATER SERVICE INC / CTexhibit312q32016.htm
EX-31.1 - CEO CERTIFICATION - CONNECTICUT WATER SERVICE INC / CTexhibit311q32016.htm


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, 2016 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
cwclogocolora01.jpg
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 a 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
11,240,417
Number of shares of common stock outstanding, October 1, 2016
(Includes 220,475 common stock equivalent shares awarded under the Performance Stock Programs)



CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
 
Financial Report
September 30, 2016
 
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, 2016
 
December 31, 2015
Utility Plant
 
$
750,127

 
$
722,447

Construction Work in Progress
 
42,943

 
23,298

 
 
793,070

 
745,745

Accumulated Provision for Depreciation
 
(209,281
)
 
(199,461
)
Net Utility Plant
 
583,789

 
546,284

Other Property and Investments
 
8,854

 
8,126

Cash and Cash Equivalents
 
1,158

 
731

Accounts Receivable (Less Allowance, 2016 - $1,009; 2015 - $947)
 
13,819

 
11,012

Accrued Unbilled Revenues
 
10,150

 
8,259

Materials and Supplies, at Average Cost
 
1,893

 
1,617

Prepayments and Other Current Assets
 
9,478

 
5,393

Total Current Assets
 
36,498

 
27,012

Restricted Cash
 

 
846

Unrecovered Income Taxes - Regulatory Asset
 
89,944

 
77,510

Pension Benefits - Regulatory Asset
 
11,173

 
12,414

Post-Retirement Benefits Other Than Pension - Regulatory Asset
 
290

 
468

Goodwill
 
30,427

 
30,427

Deferred Charges and Other Costs
 
8,851

 
7,628

Total Regulatory and Other Long-Term Assets
 
140,685

 
129,293

Total Assets
 
$
769,826

 
$
710,715

CAPITALIZATION AND LIABILITIES
 
 

 
 

Common Stockholders’ Equity:
 
 

 
 

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

 
 

     Issued and Outstanding: 2016 - 11,240,417; 2015 - 11,192,882
 
$
144,769

 
$
144,534

Retained Earnings
 
93,636

 
80,378

Accumulated Other Comprehensive (Loss)
 
(785
)
 
(935
)
Common Stockholders’ Equity
 
237,620

 
223,977

Preferred Stock
 
772

 
772

Long-Term Debt
 
200,155

 
171,868

Total Capitalization
 
438,547

 
396,617

Current Portion of Long-Term Debt
 
2,883

 
2,842

Interim Bank Loans Payable
 
21,837

 
16,085

Accounts Payable and Accrued Expenses
 
11,652

 
11,882

Accrued Interest
 
1,441

 
727

Current Portion of Refund to Customers - Regulatory Liability
 
1,229

 
2,994

Other Current Liabilities
 
2,337

 
2,409

Total Current Liabilities
 
41,379

 
36,939

Advances for Construction
 
20,175

 
21,444

Deferred Federal and State Income Taxes
 
50,976

 
48,036

Unfunded Future Income Taxes
 
87,617

 
74,712

Long-Term Compensation Arrangements
 
31,374

 
34,389

Unamortized Investment Tax Credits
 
1,208

 
1,264

Refund to Customers - Regulatory Liability
 
178

 
993

Other Long-Term Liabilities
 
4,831

 
5,273

Total Long-Term Liabilities
 
196,359

 
186,111

Contributions in Aid of Construction
 
93,541

 
91,048

Commitments and Contingencies
 

 

Total Capitalization and Liabilities
 
$
769,826

 
$
710,715


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, 2016 and 2015
(Unaudited)
(In thousands, except per share amounts)
 
2016
 
2015
Operating Revenues
$
29,477

 
$
28,444

Operating Expenses
 
 
 
Operation and Maintenance
11,495

 
12,185

Depreciation
3,449

 
3,228

Income Tax Expense
1,219

 
1,283

Taxes Other Than Income Taxes
2,535

 
2,294

Total Operating Expenses
18,698

 
18,990

Net Operating Revenues
10,779

 
9,454

Other Utility Income, Net of Taxes
160

 
255

Total Utility Operating Income
10,939

 
9,709

Other Income (Deductions), Net of Taxes
 
 
 
Gain on Real Estate Transactions
2

 
351

Non-Water Sales Earnings
181

 
296

Allowance for Funds Used During Construction
330

 
129

Other
(136
)
 
(54
)
Total Other Income, Net of Taxes
377

 
722

Interest and Debt Expense
 
 
 
Interest on Long-Term Debt
2,064

 
1,754

Other Interest Income, Net
(315
)
 
(105
)
Amortization of Debt Expense and Premium, Net
32

 
27

Total Interest and Debt Expense
1,781

 
1,676

Net Income
9,535

 
8,755

Preferred Stock Dividend Requirement
10

 
10

Net Income Applicable to Common Stock
$
9,525

 
$
8,745

Weighted Average Common Shares Outstanding:
 
 
 
Basic
11,014

 
10,970

Diluted
11,233

 
11,171

Earnings Per Common Share:
 
 
 
Basic
$
0.86

 
$
0.80

Diluted
$
0.84

 
$
0.79

Dividends Per Common Share
$
0.2825

 
$
0.2675


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, 2016 and 2015
(Unaudited)
(In thousands, except per share amounts)
 
2016
 
2015
Operating Revenues
$
77,084

 
$
75,098

Operating Expenses
 

 
 

Operation and Maintenance
31,624

 
34,688

Depreciation
10,206

 
9,525

Income Tax Expense
2,201

 
795

Taxes Other Than Income Taxes
7,222

 
6,722

Total Operating Expenses
51,253

 
51,730

Net Operating Revenues
25,831

 
23,368

Other Utility Income, Net of Taxes
503

 
615

Total Utility Operating Income
26,334

 
23,983

Other Income (Deductions), Net of Taxes
 

 
 

Gain on Real Estate Transactions
2

 
351

Non-Water Sales Earnings
982

 
1,040

Allowance for Funds Used During Construction
851

 
327

Other
(451
)
 
(165
)
Total Other Income, Net of Taxes
1,384

 
1,553

Interest and Debt Expense
 

 
 

Interest on Long-Term Debt
5,630

 
5,291

Other Interest Income, Net
(631
)
 
(369
)
Amortization of Debt Expense and Premium, Net
93

 
81

Total Interest and Debt Expense
5,092

 
5,003

Net Income
22,626

 
20,533

Preferred Stock Dividend Requirement
29

 
29

Net Income Applicable to Common Stock
$
22,597

 
$
20,504

Weighted Average Common Shares Outstanding:
 
 
 
Basic
11,004

 
10,951

Diluted
11,223

 
11,157

Earnings Per Common Share:
 
 
 
Basic
$
2.05

 
$
1.87

Diluted
$
2.01

 
$
1.84

Dividends Per Common Share
$
0.8325

 
$
0.7825


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, 2016 and 2015
(Unaudited)
(In thousands)

 
2016
 
2015
Net Income
$
9,535

 
$
8,755

Other Comprehensive Income/(Loss), net of tax
 

 
 

Reclassification to Pension and Post-Retirement Benefits Other than Pension, net of tax (expense) of $(25) and $(31) in 2016 and 2015
39

 
48

Unrealized gain (loss) on investments, net of tax (expense) benefit of $(29) and $44 in 2016 and 2015
46

 
(70
)
Other Comprehensive Income/(Loss), net of tax
85

 
(22
)
Comprehensive Income
$
9,620

 
$
8,733




CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Nine Months Ended September 30, 2016 and 2015
(Unaudited)
(In thousands)

 
2016
 
2015
Net Income
$
22,626

 
$
20,533

Other Comprehensive Income, net of tax
 

 
 

Reclassification to Pension and Post-Retirement Benefits Other than Pension, net of tax (expense) of $(75) and $(92) in 2016 and 2015
117

 
117

Unrealized gain (loss) on investments, net of tax (expense) benefit of $(21) and $75 in 2016 and 2015
33

 
(118
)
Other Comprehensive Income/(Loss), net of tax
150

 
(1
)
Comprehensive Income
$
22,776

 
$
20,532




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, 2016 and 2015
(Unaudited)
(In thousands, except per share amounts)

 
2016
 
2015
Balance at Beginning of Period
$
87,284

 
$
75,386

Net Income
9,535

 
8,755

 
96,819

 
84,141

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 - 2016 $0.2825 per share; 2015 $0.2675 per share
3,173

 
2,984

 
3,183

 
2,994

Balance at End of Period
$
93,636

 
$
81,147




CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF RETAINED EARNINGS
For the Nine Months Ended September 30, 2016 and 2015
(Unaudited)
(In thousands, except per share amounts)

 
2016
 
2015
Balance at Beginning of Period
$
80,378

 
$
69,370

Net Income
22,626

 
20,533

 
103,004

 
89,903

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 - 2016 $0.8325 per share; 2015 $0.7825 per share
9,339

 
8,727

 
9,368

 
8,756

Balance at End of Period
$
93,636

 
$
81,147




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, 2016 and 2015
(Unaudited)
(In thousands)
 
2016
 
2015
Operating Activities:
 
 
 
Net Income
$
22,626

 
$
20,533

Adjustments to Reconcile Net Income to Net Cash and Cash Equivalents Provided by
 

 
 

Operating Activities:
 

 
 

Deferred Revenues
(2,688
)
 
(3,395
)
Provision for Deferred Income Taxes and Investment Tax Credits, Net
3,244

 
(4,844
)
Allowance for Funds Used During Construction
(851
)
 
(327
)
Depreciation and Amortization (including $744 and $590 in 2016 and 2015, respectively, charged to other accounts)
10,950

 
10,115

Gain on Real Estate Transactions
(2
)
 
(351
)
Change in Assets and Liabilities:
 

 
 

Increase in Accounts Receivable and Accrued Unbilled Revenues
(4,699
)
 
(2,838
)
Increase in Prepaid Income Taxes and Prepayments and Other Current Assets
(4,270
)
 
(571
)
(Increase) Decrease in Other Non-Current Items
(2,908
)
 
10,778

Decrease in Accounts Payable, Accrued Expenses and Other Current Liabilities
(511
)
 
(1,648
)
Total Adjustments
(1,735
)
 
6,919

Net Cash and Cash Equivalents Provided by Operating Activities
20,891

 
27,452

Investing Activities:
 

 
 

Net Additions to Utility Plant Used
(47,470
)
 
(30,260
)
Proceeds from the Sale of Land
9

 
6

Release of Restricted Cash
846

 

Net Cash and Cash Equivalents Used in Investing Activities
(46,615
)
 
(30,254
)
Financing Activities:
 

 
 

Net Proceeds from Interim Bank Loans
21,837

 
11,442

Net Repayment of Interim Bank Loans
(16,085
)
 
(1,991
)
Proceeds from the Issuance of Long-Term Debt
49,930

 
1,849

Costs to Issue Long-Term Debt and Common Stock
(88
)
 
(5
)
Proceeds from Issuance of Common Stock
1,232

 
1,134

Repayment of Long-Term Debt Including Current Portion
(21,608
)
 
(1,319
)
Advances from Others for Construction
301

 
159

Cash Dividends Paid
(9,368
)
 
(8,756
)
Net Cash and Cash Equivalents Provided by (Used in) Financing Activities
26,151

 
2,513

Net Increase (Decrease) in Cash and Cash Equivalents
427

 
(289
)
Cash and Cash Equivalents at Beginning of Period
731

 
2,475

Cash and Cash Equivalents at End of Period
$
1,158

 
$
2,186

Non-Cash Investing and Financing Activities:
 

 
 

Non-Cash Contributed Utility Plant
$
1,045

 
$
966

Supplemental Disclosures of Cash Flow Information:
 

 
 

Cash Paid for:
 

 
 

Interest
$
4,410

 
$
4,306

State and Federal Income Taxes
$
295

 
$
437


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. (the “Company”) and its wholly-owned subsidiaries, 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 Company’s primary operating subsidiaries are: The Connecticut Water Company (“Connecticut Water”) and The Maine Water Company (“Maine Water”). The Condensed Consolidated Balance Sheet at December 31, 2015 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, 2015 (the “10-K”) and as updated in the Company’s Quarterly Report on Forms 10-Q for the periods ending March 31, 2016 and June 30, 2016.

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.

During the preparation of the Condensed Consolidated Financial Statements for the quarter ended June 30, 2016, the Company identified two errors related to the accounting treatment of stock-based performance awards granted to officers of the Company. First, the Company had mistakenly classified all stock-based performance awards as equity awards and, secondly, incorrectly marked those awards to the market price of the Company’s common stock price at the end of each reporting period. A portion of these awards should have been classified as liability awards and only those awards should have been marked-to-market based on the Company’s common stock price. During the second quarter of 2016, the Company reversed all of the incorrectly recorded mark-to-market expense as a cumulative out-of-period adjustment resulting in a one-time benefit of approximately $2.6 million on the Operation and Maintenance line item on its Condensed Consolidated Statements of Income for the three months ended June 30, 2016 and $1.6 million for the six months ended June 30, 2016. Approximately $1.6 million of the out of period adjustment pertained to years prior to 2016, with the remaining $1.0 million related to the first quarter of 2016. Additionally, the Company decreased its Common Stock Without Par Value and increased its Long-Term Compensation Arrangement line items on the Condensed Consolidated Balance Sheet as of June 30, 2016 by approximately $0.6 million to reflect both the awards that should have been classified as liability awards and their corresponding mark-to-market adjustments.

The Company performed various quantitative and qualitative analyses and determined that these errors were not material to the previously reported quarterly and annual results. The Company also determined that recording these entries as an out-of- period adjustment during the second quarter of 2016 is not expected to be material to the projected results for the full year ended December 31, 2016.

Certain previously reported information has been reclassified to conform to the current period presentation.

Regulatory Matters

The rates we charge our water customers in Connecticut and Maine are established under the jurisdiction of and are approved by the Connecticut Public Utilities Regulatory Authority (“PURA”) and the Maine Public Utilities Commission (“MPUC”), respectively. 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 September 30, 2016, were 9.75% and 7.32%, respectively. Maine Water’s average allowed return on equity and return on rate base, effective September 30, 2016, were 9.50% and 7.96%, respectively. The PURA establishes rates in Connecticut on a company-wide basis while the MPUC approves Maine Water’s rates on a division-by-division basis. Both Connecticut Water and Maine Water are allowed to add surcharges to customers’ bills in order to recover certain approved capital projects in between full rate cases, as well as approved surcharges for Water Revenue Adjustments, as discussed in more detail below, in Connecticut.

Heritage Village Water Company Acquisition
On May 10, 2016, the Company entered into an Agreement and Plan of Merger (the “HVWC Agreement”) with Heritage Village Water Company, a specially-chartered Connecticut corporation (“HVWC”). Founded in 1969, HVWC is based in Southbury, Connecticut, and serves approximately 4,700 water and 3,000 waste water customers in the southern Connecticut communities of Southbury, Middlebury and Oxford.

9

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


The Boards of Directors of the Company and HVWC have each unanimously approved the HVWC Agreement. Consummation of the merger is subject to regulatory, HVWC shareholder and other specified approvals described below and is expected to be completed during either the fourth quarter of 2016 or the first quarter of 2017.

Under the terms of the HVWC Agreement, each share of HVWC common stock issued and outstanding at the time of the closing of the Merger will be exchanged and converted into the right to receive 240 shares of the common stock of the Company, without par value (the “Company Common Stock”), provided that the Company’s Share Price (as defined below) over a specified period prior to the closing date of the Merger is equal to or greater than $39.45 but less than or equal to $41.45. If the Company’s Share Price is less than $39.45 as of the closing date, each share of HVWC common stock issued and outstanding at the time of the closing of the Merger will be exchanged and converted into the right to receive that number of shares of Company Common Stock equal to $9,468 divided by the Company’s Share Price. If the the Company’s Share Price is more than $41.45 as of the closing date, each share of HVWC common stock issued and outstanding at the time of the closing of the Merger will be exchanged and converted into the right to receive that number of shares of the Company’s Common Stock equal to $9,948 divided by the Company’s Share Price. The “Company’s Share Price” is determined by calculating an average of the closing prices for shares of the Company’s Common Stock on the Nasdaq Stock Market, LLC for the twenty trading days immediately preceding the third business day prior to the closing of the Merger. Holders of HVWC common stock prior to the Merger will receive cash in lieu of fractional shares of Company Common Stock.

The HVWC Agreement contains customary representations and warranties regarding, on the one hand, HVWC, its business and operations and related matters, and, on the other hand, the Company, made by the parties as of specified dates, and customary affirmative and negative covenants with respect to the conduct of HVWC’s business prior to the closing. In the HVWC Agreement, HVWC has agreed that its Board of Directors will, subject to certain exceptions, recommend adoption of the HVWC Agreement by HVWC shareholders and the transactions contemplated by the HVWC Agreement. HVWC has also agreed: (i) to cause a special meeting of shareholders of HVWC to be held to consider the approval and adoption of the HVWC Agreement and the transactions contemplated thereby; and (ii) not to solicit proposals relating to alternative business combination transactions or, subject to certain exceptions, enter into discussions concerning confidential information in connection with alternative business combination transactions.

The obligation of the parties to complete the Merger is subject to the satisfaction or waiver on or prior to the closing date of certain specified conditions, including the following: (i) receipt of a final and non-appealable order of PURA approving the Merger in form and substance reasonably acceptable to the parties; (ii) approval of the Merger by the affirmative vote of the holders of not less than two-thirds (66 2/3rd%) of HVWC’s issued and outstanding shares of common stock as required under the Connecticut Business Corporation Act (“CBCA”) and by a super-majority vote of ninety (90%) percent of HVWC’s issued and outstanding shares; (iii) the completion of certain specified corporate governance steps regarding HVWC’s Board of Directors, including the appointment of up to three additional directors; (iv) the receipt of all other necessary consents or approvals to the Merger; (v) approval for listing of the Company Common Stock to be issued in the Merger on the Nasdaq Stock Market, LLC; (vi) the absence of laws, orders, judgments and injunctions that restrain, enjoin or otherwise prohibit consummation of the Merger; (vii) effectiveness under the Securities Act of 1933 (the “Securities Act”) of the Company’s registration statement on Form S-4 relating to the issuance of the Company Common Stock in the Merger and absence of any stop order in respect thereof or proceedings by the Securities and Exchange Commission (“SEC”) for that purpose; (viii) the receipt of customary tax opinions from counsel to HVWC and the Company that will state that the Merger will qualify as a tax-free reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986; (ix) the accuracy of representations and warranties with respect to the businesses of HVWC and the Company and compliance by HVWC and the Company with their respective covenants contained in the HVWC Agreement; (x) no event(s) occurring that could reasonably be expected to result in a “Company Material Adverse Effect” (as defined in the HVWC Agreement) and (xi) holders of no more than 5% of HVWC’s common stock have exercised appraisal rights under Connecticut law.

The parties’ obligation to complete the Merger is also subject to a closing condition related to HVWC’s enabling legislation adopted in 1969. The special act of the Connecticut legislature that formed HVWC provides a right of first refusal (“ROFR”) to the Town of Southbury, Connecticut to purchase HVWC on the same terms and conditions as those set forth in the HVWC Agreement. The Town has a statutory period of ninety (90) days following receipt of notice from HVWC to exercise its right to purchase HVWC on such same terms and conditions. This notice was delivered to the Town on May 10, 2016.

On July 28, 2016, the Town of Southbury filed a lawsuit against HVWC and Connecticut Water in Connecticut state court seeking an injunction to preclude the parties from completing the merger or taking other actions that the Town believes will prevent the Town from fully enforcing its ROFR rights. On August 5, 2016, a hearing was held in Waterbury Superior Court at which the Court ordered that the Town’s ROFR deadline be extended to November 14, 2016. The Court’s order allows the Company to continue the approval process, with both state utility regulators and the SEC.

10

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


The HVWC Agreement contains certain termination rights for both the Company and HVWC and further provides that, in connection with the termination of the HVWC Agreement under specified circumstances, HVWC may be required to pay to the Company, or the Company may be required to pay to HVWC, a termination fee of $100,000 in cash, as liquidated damages.

On July 7, 2016, Connecticut Water filed an application with PURA seeking approval of the acquisition. PURA has issued interrogatories, to which the Company has responded, and held public hearings. Based on PURA’s schedule, the Company expects a decision t be rendered by PURA in December 2016.

Avon Water Company Acquisition
On October 11, 2016, the Company entered into an Agreement and Plan of Merger (the “Avon Agreement”) with The Avon Water Company, a specially-chartered Connecticut corporation (“Avon Water”). Founded in 1911, Avon Water serves about 4,800 customers in the Farmington Valley communities of Avon, Farmington, and Simsbury, Connecticut, and is located near Connecticut Water’s existing operations in Avon and Farmington.

The Boards of Directors of the Company and Avon Water have each unanimously approved the Avon Agreement and the transactions contemplated thereby. Consummation of the merger is subject to regulatory, Avon Water shareholder and other specified approvals described below and is expected to be consummated by the end of the first quarter of 2017.

Under the terms of the Avon Agreement, each of the 121,989 Avon Water common stock shares outstanding at the time of the closing of the merger will be exchanged and converted into the right to receive the following merger consideration: (i) a cash payment of $50.37; and (ii) a stock consideration component, consisting of 4.38 Company Common Stock, provided that the Company’s Share Price (as defined above) over a specified period prior to the closing date of the merger is equal to or greater than $45.00 but less than or equal to $52.00. If the Company’s Share Price is less than $45.00 as of the closing date, each share of Avon Water common stock issued and outstanding at the time of the closing of the merger will be exchanged and converted into the right to receive that number of shares of Company Common Stock equal to 197.10 divided by the Company’s Share Price, rounded to the nearest hundredth. If the Company’s Share Price is more than $52.00 as of the closing date, each share of Avon Water common stock issued and outstanding at the time of the closing of the merger will be exchanged and converted into the right to receive that number of shares of Company Common Stock equal to 227.76 divided by the Company’s Share Price, rounded to the nearest hundredth. Holders of Avon Water common stock prior to the Merger will receive cash in lieu of fractional shares of Company Common Stock.

The Avon Agreement contains customary representations and warranties regarding, on the one hand, Avon Water, its business and operations and related matters, and, on the other hand, the Company, made by the parties as of specified dates, and customary affirmative and negative covenants with respect to the conduct of Avon Water’s business prior to the closing. In the Avon Agreement, Avon Water has agreed that its Board of Directors will, subject to certain exceptions, recommend adoption of the Avon Agreement by Avon Water shareholders and the transactions contemplated by the Avon Agreement. Avon Water has also agreed: (i) to cause a special meeting of shareholders of Avon Water to be held to consider the approval and adoption of the Agreement and the transactions contemplated thereby; and (ii) not to solicit proposals relating to alternative business combination transactions or, subject to certain exceptions, enter into discussions concerning confidential information in connection with alternative business combination transactions.

The obligation of the parties to complete the merger is subject to the satisfaction or waiver on or prior to the closing date of certain specified conditions, including the following: (i) receipt of a final and non-appealable order of PURA approving the merger in form and substance reasonably acceptable to the parties; (ii) approval of the merger by the affirmative vote of the holders of not less than two-thirds (66 2/3rd %) Avon Water’s issued and outstanding shares of common stock as required under the CBCA; (iii) the receipt of all other necessary consents or approvals to the merger; (iv) approval for listing of the Company Common Stock to be issued in the merger on the Nasdaq Stock Market, LLC; (v) the absence of laws, orders, judgments and injunctions that restrain, enjoin or otherwise prohibit consummation of the Merger; (vi) effectiveness under the Securities Act of the Company’s registration statement on Form S-4 relating to the issuance of the Company Common Stock in the merger and absence of any stop order in respect thereof or proceedings by the SEC for that purpose; (vii) the receipt of a legal opinion from counsel to Avon Water regarding certain corporate law matters; (viii) the receipt of a customary tax opinion from counsel to the Company that will state that the merger will qualify as a tax-free reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986; (ix) the accuracy of representations and warranties with respect to the businesses of Avon Water and the Company and compliance by Avon Water and the Company with their respective covenants contained in the Avon Agreement; (xi) no event(s) occurring that could reasonably be expected to result in either a “Company Material Adverse Effect” or a “CWS Material Adverse Effect” (each, as defined in the Avon Agreement) and (xii) holders of no more than 5% of Avon Water’s common stock have exercised appraisal rights under Connecticut law.


11

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The Avon Agreement contains certain termination rights for both the Company and Avon Water and further provides that, in connection with the termination of the Avon Agreement under specified circumstances, Avon Water may be required to pay to the Company, or the Company may be required to pay to Avon Water, a termination fee of $200,000 in cash, as liquidated damages.

During the fourth quarter of 2016, Connecticut Water expects to file an application with PURA seeking approval of the transaction.

Maine Water Land Sale
On March 11, 2016, Maine Water entered into a purchase and sale agreement with the Coastal Mountains Land Trust, a Maine nonprofit corporation (the “Land Trust”) pursuant to which Maine Water agreed to sell two conservation easements to the Land Trust on approximately 1,300 acres of land located in the towns of Rockport, Camden and Hope, in Knox County, Maine valued in the aggregate at $3.1 million.  The land had a book value of approximately $600,000 at December 31, 2015 and is included in “Utility Plant” on the Company’s “Consolidated Balance Sheets”. The easements and purchase prices are as follows:

1.Ragged Mountain Mirror Lake Conservation Easement: $1,875,000; and
2.Grassy Pond conservation Easement: $600,000.

The two easement sale and donation transactions are expected to close no later than December 31, 2017 and December 31, 2019, respectively.  Maine Water will make a $200,000 contribution to the Land Trust upon completion of the closing of the first easement sale.  Maine Water also expects to claim a charitable deduction for the $600,000 in excess of the fair market value of the second easement over the $600,000 sale price.

Connecticut Rates
In Connecticut, the Water Infrastructure Conservation Adjustment (“WICA”) was 3.04% and 5.12% at September 30, 2015 and 2016, respectively. On July 27, 2016, Connecticut Water filed a WICA application with the PURA requesting a 2.01% surcharge to customers’ bills, representing approximately $12.8 million in WICA related projects. On September 21, 2016, PURA approved the application as filed, effective October 1, 2016, the Company’s cumulative WICA surcharge was 7.13%. WICA surcharges are capped at 10% between general rate cases.

Since 2013, Connecticut law has authorized a Water Revenue Adjustment (“WRA”) to reconcile actual water demands with the demands projected in the last general rate case and allows companies to adjust rates as necessary to recover the revenues approved by PURA in the last general rate case. The WRA removes the financial disincentive for water utilities to develop and implement effective water conservation programs. The WRA allows water companies to defer on the balance sheet, as a regulatory asset or liability, for later collection from or crediting to customers the amount by which actual revenues deviate from the revenues allowed in the most recent general rate proceedings, including WICA proceedings. Additionally, projects eligible for WICA surcharges were expanded to include energy conservation projects, improvements required to comply with streamflow regulations, and improvements to acquired systems.

Connecticut Water’s allowed revenues for the nine months ended September 30, 2016, as approved by PURA during our 2010 general rate case and including subsequently approved WICA surcharges, are approximately $59.1 million. Through normal billing for the nine months ended September 30, 2016, revenue for Connecticut Water would have been approximately $56.2 million had the WRA not been implemented. As a result of the implementation of the WRA, Connecticut Water recorded $2.9 million in additional revenue for the nine months ended September 30, 2016.

Maine Rates
In Maine, the overall, cumulative Water Infrastructure Charge (“WISC”) for all divisions was 1.13% and 4.08% as of September 30, 2015 and 2016, respectively.

In 2014 and 2015, Maine Water petitioned the MPUC for approval of accounting orders that would address (1) the return to its customers a federal income tax refund stemming from the adoption of the Internal Revenue Service (“IRS”) Revenue Procedure 2012-19 (“Repair Regulations”), and (2) the treatment of any benefit resulting from the elimination of deferred tax liabilities previously recorded on these qualifying fixed assets that are now deducted under the Repair Regulations.

On February 26, 2015, the MPUC approved a stipulation between Maine Water and the Office of the Public Advocate that refunds $2.9 million to the customers of the eight divisions over a two-year period starting no later than July 1, 2015, and allows the flow-through treatment of the repair deduction as of January 1, 2014. In addition, Maine Water agreed not to file a general rate case during the two-year refund period in any of the eight divisions that were allowed the refund.

12

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


On June 22, 2015, the MPUC approved a settlement agreement between Maine Water and the Office of the Public Advocate that allowed for the amortization of the deferred tax liabilities over a one to nine year period, depending on the division. Maine Water commenced amortization per the agreed upon schedule.

With the completion of these two dockets, Maine Water recorded in the quarter ended June 30, 2015 the retroactive benefit associated with the flow-through of the Repair Regulations from January 1, 2014. The 2014 benefit, reflected in the second quarter of 2015, was approximately $931,000, or $0.09 per basic share outstanding.

A newly passed water revenue adjustment mechanism law in Maine became available to regulated water utilities in Maine on October 15, 2015. Maine Water is currently precluded from seeking new rates due to various agreements with the MPUC, but is evaluating how and when this new mechanism can be implemented.

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, 2016 and 2015.

Pension Benefits
Components of Net Periodic Cost (in thousands):
 
Three Months
 
Nine Months
Period ended September 30,
2016
 
2015
 
2016
 
2015
Service Cost
$
474

 
$
538

 
$
1,421

 
$
1,614

Interest Cost
803

 
778

 
2,409

 
2,335

Expected Return on Plan Assets
(1,020
)
 
(961
)
 
(3,060
)
 
(2,885
)
Amortization of:
 

 
 

 
 
 
 
Prior Service Cost
4

 
4

 
12

 
12

Net Recognized Loss
512

 
744

 
1,537

 
2,234

Net Periodic Benefit Cost
$
773

 
$
1,103

 
$
2,319

 
$
3,310


The Company has made a total contribution of approximately $5,525,000 in 2016 for the 2015 plan year during the nine months ended September 30, 2016.

Post-Retirement Benefits Other Than Pension (PBOP)
Components of Net Periodic Cost (in thousands):
 
Three Months
 
Nine Months
Period ended September 30,
2016
 
2015
 
2016
 
2015
Service Cost
$
94

 
$
114

 
$
282

 
$
343

Interest Cost
135

 
141

 
406

 
423

Expected Return on Plan Assets
(86
)
 
(81
)
 
(256
)
 
(243
)
Other
57

 
57

 
169

 
169

Amortization of:
 

 
 

 
 
 
 
Prior Service Credit
(100
)
 
(142
)
 
(300
)
 
(428
)
Recognized Net Loss
8

 
97

 
27

 
290

Net Periodic Benefit Cost
$
108

 
$
186

 
$
328

 
$
554



13

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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 stock awards):

Three months ended September 30,
2016
 
2015
Common Shares Outstanding End of Period:
11,240,417

 
11,180,146

Weighted Average Shares Outstanding (Days Outstanding Basis):
 

 
 

Basic
11,014,002

 
10,970,107

Diluted
11,233,375

 
11,170,813

 
 
 
 
Basic Earnings per Share
$
0.86

 
$
0.80

Dilutive Effect of Stock Awards
(0.02
)
 
(0.01
)
Diluted Earnings per Share
$
0.84

 
$
0.79

 
 
 
 
Nine months ended September 30,
 
 
 
Weighted Average Shares Outstanding (Days Outstanding Basis):
 
 
 
Basic
11,003,644

 
10,950,837

Diluted
11,222,588

 
11,157,400

 
 
 
 
Basic Earnings per Share
$
2.05

 
$
1.87

Dilutive Effect of Stock Awards
(0.04
)
 
(0.03
)
Diluted Earnings per Share
$
2.01

 
$
1.84


Total unrecognized compensation expense for all stock awards was approximately $0.8 million as of September 30, 2016 and will be recognized over a weighted average period of 1.3 years.

4.
Recently Adopted and New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” (“No. 2014-09”) which amends its guidance related to revenue recognition. ASU No. 2014-09 requires an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. The following steps are applied in the updated guidance: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. ASU No. 2014-09 is effective for public companies for fiscal years, and interim periods within those years, beginning after December 15, 2016, and can be adopted either retrospectively to each prior reporting period presented or as a cumulative-effect adjustment as of the date of adoption, however early adoption is not permitted. On April 1, 2015, the FASB voted for a one-year deferral of the effective date of ASU No. 2014-09, making ASU No. 2014-09 effective for public companies for fiscal years, and interim periods within those years, beginning after December 15, 2017. The Company is currently determining its implementation approach and assessing the impact that this guidance may have on our consolidated financial position, including its impact on the Company’s contracted services provided to water and wastewater utilities.

In April 2015, the FASB issued ASU 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs” (“ASU No. 2015-03”). The update requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability instead of being presented as an asset. Debt disclosures will include the face amount of the debt liability and the effective interest rate. The update requires retrospective application and represents a change in accounting principle. The update is effective for fiscal years beginning after December 15, 2015. The Company has adopted ASU No. 2015-03, effective January 1, 2016, which had the effect of reducing the December 31, 2015 Long-Term Debt balance by $5,786,000 on the Condensed Consolidated Balance Sheet.


14

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory,” (“ASU No. 2015-11”) which applies to inventory that is measured using first-in, first-out (“FIFO”) or average cost. Under the updated guidance, an entity should measure inventory that is within scope at the lower of cost or net realizable value, which is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. Subsequent measurement is unchanged under the updated guidance for inventory that is measured using last-in, last-out (“LIFO”). This ASU is effective for annual and interim periods beginning after December 15, 2016, and should be applied prospectively with early adoption permitted at the beginning of an interim or annual reporting period. The Company uses average cost to value its inventory and, therefore, ASU No. 2015-11 will not have an impact on the Company.

In November 2015, the FASB issued ASU No. 2015-17, “Income Taxes (Topic 740), Balance Sheet Classification of Deferred Taxes” (“ASU No. 2015-17”). ASU No. 2015-17 requires net deferred tax assets and liabilities to be classified as non-current on the Company’s Consolidated Balance Sheets. Prior to adoption of the new standard, net deferred tax assets and liabilities were presented separately as current and non-current on the Consolidated Balance Sheets.  ASU No. 2015-17 is effective for financial statements issued for annual periods beginning after December 15, 2016 and interim periods within those annual periods. Early adoption is permitted. The Company has adopted ASU No. 2015-17, effective January 1, 2016, which had the effect of reducing the December 31, 2015 Prepayments and Other Current Assets and Deferred Federal and State Income Taxes balances by $17,000 on the Condensed Consolidated Balance Sheet.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)”, (“ASU No. 2016-02”), which will require lessees to recognize the following for all leases at the commencement date of a lease: a) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and b) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Public business entities should apply the amendments in ASU No. 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted for all public business entities and all nonpublic business entities upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently assessing the impact of this standard on its consolidated financial statements and footnote disclosures, but does not expect that the adoption of this guidance will materially impact our consolidated financial position.

In March 2016, the FASB issued ASU 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU No. 2016-09”). ASU No. 2016-09 impacts several aspects of the accounting for share-based payment transactions, including classification of certain items on the Consolidated Statement of Cash Flows and accounting for income taxes.  Specifically, ASU No. 2016-09 requires that excess tax benefits and tax deficiencies (the difference between the deduction for tax purposes and the compensation cost recognized for financial reporting purposes) be recognized as income tax expense or benefit in the Consolidated Statements of Income, introducing a new element of volatility to the provision for income taxes. ASU No. 2016-09 is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. The Company adopted ASU No. 2016-09 during the second quarter of 2016, which had the effect of decreasing the Other line item on the Condensed Consolidated Statement of Income for the nine months ended September 30, 2016 by approximately $19,000.


15

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

5.
Accumulated Other Comprehensive Income

The changes in Accumulated Other Comprehensive Income (Loss) (“AOCI”) by component, net of tax, for the three and nine months ended September 30, 2016 and 2015 are as follows (in thousands):
Three months ended September 30, 2016
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
187

 
$
(1,057
)
 
$
(870
)
Other Comprehensive Income Before Reclassification
 
46

 

 
46

Amounts Reclassified from AOCI
 

 
39

 
39

Net current-period Other Comprehensive Income
 
46

 
39

 
85

Ending Balance
 
$
233

 
$
(1,018
)
 
$
(785
)
 
 
 
 
 
 
 
Three months ended September 30, 2015
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
250

 
$
(1,832
)
 
$
(1,582
)
Other Comprehensive (Loss) Income Before Reclassification
 
(70
)
 

 
(70
)
Amounts Reclassified from AOCI
 

 
48

 
48

Net current-period Other Comprehensive (Loss) Income
 
(70
)
 
48

 
(22
)
Ending Balance
 
$
180

 
$
(1,784
)
 
$
(1,604
)
 
 
 
 
 
 
 
Nine months ended September 30, 2016
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
200

 
$
(1,135
)
 
$
(935
)
Other Comprehensive Income Before Reclassification
 
23

 

 
23

Amounts Reclassified from AOCI
 
10

 
117

 
127

Net current-period Other Comprehensive Income
 
33

 
117

 
150

Ending Balance
 
$
233

 
$
(1,018
)
 
$
(785
)
 
 
 
 
 
 
 
Nine months ended September 30, 2015
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
298

 
$
(1,901
)
 
$
(1,603
)
Other Comprehensive (Loss) Income Before Reclassification
 
(193
)
 
(65
)
 
(258
)
Amounts Reclassified from AOCI
 
75

 
182

 
257

Net current-period Other Comprehensive (Loss) Income
 
(118
)
 
117

 
(1
)
Ending Balance
 
$
180

 
$
(1,784
)
 
$
(1,604
)
 
 
 
 
 
 
 
(a) All amounts shown are net of tax. Amounts in parentheses indicate loss.


16

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following table sets forth the amounts reclassified from AOCI by component and the affected line item on the Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2016 and 2015 (in thousands):
Details about Other AOCI Components
 
Amounts Reclassified from AOCI Three Months Ended September 30, 2016(a)
 
Amounts Reclassified from AOCI Three Months Ended September 30, 2015(a)
 
Affected Line Items on Income Statement
Realized Gains on Investments
 
$

 
$

 
Other Income
Tax expense
 

 

 
Other Income
 
 

 

 
 
 
 
 
 
 
 
 
Amortization of Recognized Net Gain from Defined Benefit Items
 
64

 
79

 
Other Income (b)
Tax expense
 
(25
)
 
(31
)
 
Other Income
 
 
39

 
48

 
 
 
 
 
 
 
 
 
Total Reclassifications for the period, net of tax
 
$
39

 
$
48

 
 
 
 
 
 
 
 
 
Details about Other AOCI Components
 
Amounts Reclassified from AOCI Nine Months Ended September 30, 2016(a)
 
Amounts Reclassified from AOCI Nine Months Ended September 30, 2015(a)
 
Affected Line Items on Income Statement
Realized Gains on Investments
 
$
17

 
$
128

 
Other Income
Tax expense
 
(7
)
 
(53
)
 
Other Income
 
 
10

 
75

 
 
 
 
 
 
 
 
 
Amortization of Recognized Net Gain from Defined Benefit Items
 
192

 
275

 
Other Income (b)
Tax expense
 
(75
)
 
(93
)
 
Other Income
 
 
117

 
182

 
 
 
 
 
 
 
 
 
Total Reclassifications for the period, net of tax
 
$
127

 
$
257

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


17

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

6.
Long-Term Debt

Long-Term Debt at September 30, 2016 and December 31, 2015 consisted of the following (in thousands):
 
2016
 
2015
Connecticut Water Service, Inc.:
 
 
 
4.09%
 
Term Loan Note
$
13,700

 
$
14,472

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

5.10%
 
2009 A Series, Due 2039

 
19,930

5.00%
 
2011 A Series, Due 2021
23,163

 
23,303

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

 
14,550

4.36%
 
CoBank Note Payable, Due June 2036
30,000

 

4.04%
 
CoBank Note Payable, Due July 2036
19,930

 

Total The Connecticut Water Company
164,303

 
134,443

The Maine Water Company:
 
 
 
8.95%
 
1994 Series G, Due 2024
8,100

 
8,100

2.68%
 
1999 Series J, Due 2019
254

 
339

0.00%
 
2001 Series K, Due 2031
615

 
656

2.58%
 
2002 Series L, Due 2022
68

 
75

1.53%
 
2003 Series M, Due 2023
341

 
361

1.73%
 
2004 Series N, Due 2024
371

 
401

0.00%
 
2004 Series O, Due 2034
120

 
127

1.76%
 
2006 Series P, Due 2026
391

 
411

1.57%
 
2009 Series R, Due 2029
217

 
227

0.00%
 
2009 Series S, Due 2029
582

 
628

0.00%
 
2009 Series T, Due 2029
1,634

 
1,760

0.00%
 
2012 Series U, Due 2042
154

 
160

1.00%
 
2013 Series V, Due 2033
1,335

 
1,360

2.52%
 
CoBank Note Payable, Due 2017
1,965

 
1,965

4.24%
 
CoBank Note Payable, Due 2024
4,500

 
4,500

7.72%
 
Series L, Due 2018
2,250

 
2,250

2.40%
 
Series N, Due 2022
1,101

 
1,176

1.86%
 
Series O, Due 2025
790

 
830

2.23%
 
Series P, Due 2028
1,294

 
1,324

0.01%
 
Series Q, Due 2035
1,771

 
1,864

1.00%
 
Series R, Due 2025
2,250

 
2,488

Various
 
Various Capital Leases
9

 
17

Total The Maine Water Company
30,112

 
31,019

Add: Acquisition Fair Value Adjustment
381

 
562

Less: Current Portion
(2,883
)
 
(2,842
)
Less: Unamortized Debt Issuance Expense
(5,458
)
 
(5,786
)
Total Long-Term Debt
$
200,155

 
$
171,868



18

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

There are no mandatory sinking fund payments required on Connecticut Water’s outstanding 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 March 17, 2015, Maine Water completed the issuance of $1,864,050 aggregate principal amount of its First Mortgage Bonds, Series Q, 0.01% due March 17, 2035 (the “Series Q Bonds”). The Series Q Bonds were issued by Maine Water to the Bank and the proceeds of the issuance were loaned (the “Series Q Loan”) by the Maine Municipal Bond Bank (the “Bank”) to Maine Water pursuant to a Loan Agreement by and between Maine Water and the Bank dated as of March 17, 2015. The proceeds of the Series Q Loan were used by Maine Water to fund various water facilities projects, including the replacement of a booster station and modifications to a treatment plant, each located in the City of Biddeford, Maine.

On November 25, 2015, Maine Water completed the issuance of $2,487,630 aggregate principal amount of its First Mortgage Bonds, Series R, 1.0% due November 25, 2025 (the “Series R Bonds”). The Series R Bonds were issued by Maine Water to the Bank and the proceeds of the issuance were loaned (the “Series R Loan”) by the Bank to Maine Water pursuant to a Loan Agreement by and between Maine Water and the Bank dated as of November 25, 2015. The proceeds of the Series R Loan were used by Maine Water to fund the construction of a 3 million gallon water storage tank, located in the City of Biddeford, Maine, which replaced an existing in-ground 7.5 million gallon reservoir.

In April 2016, Connecticut Water filed an application with PURA to issue promissory notes in the aggregate principal amount of up to $49,930,000 with CoBank, ACB (“CoBank”) under its existing Master Loan Agreement by and between Connecticut Water and CoBank dated October 29, 2012, in order for Connecticut Water to redeem its $19,930,000 2009A Series of outstanding Water Facility Revenue Bonds previously issued by the Connecticut Development Authority (the “2009A Bonds”) and to provide $30,000,000 to partially fund its ongoing construction program. On June 1, 2016, Connecticut Water issued $30,000,000, at 4.36%, in debt under its existing Master Loan Agreement with CoBank, with a maturity date of May 20, 2036. On July 7, 2016, Connecticut Water issued $19,930,000, at 4.04%, in debt under its existing Master Loan Agreement with CoBank, with a maturity date of July 7, 2036. Connecticut Water used the proceeds to immediately pay off the $19,930,000 2009A Series of outstanding Water Facility Revenue Bonds.

In addition to paying off the 2009 A Series, Due 2039 using the proceeds of the July CoBank issuance discussed above, during the first nine months of 2016, the Company paid approximately $772,000 related to Connecticut Water Service’s Term Note Payable issued as part of the 2012 acquisition of Maine Water and approximately $905,000 in sinking funds related to Maine Water’s outstanding bonds.

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%. Additionally, Maine Water has restrictions on cash dividends paid based on restricted net assets. The Company and its subsidiaries were in compliance with all covenants at September 30, 2016.

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.


19

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following table summarizes our financial instruments measured at fair value on a recurring basis within the fair value hierarchy as of September 30, 2016 (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Asset Type:
 
 
 
 
 
 
 
Company Owned Life Insurance
$

 
$
3,078

 
$

 
$
3,078

Money Market Fund
69

 

 

 
69

Mutual Funds:
 

 
 

 
 

 
 

Equity Funds (1)
1,447

 

 

 
1,447

Fixed Income Funds (2)
467

 

 

 
467

Total
$
1,983

 
$
3,078

 
$

 
$
5,061


The following table summarizes our financial instruments measured at fair value on a recurring basis within the fair value hierarchy as of December 31, 2015 (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Asset Type:
 
 
 
 
 
 
 
Company Owned Life Insurance
$

 
$
2,909

 
$

 
$
2,909

Money Market Fund
122

 

 

 
122

Mutual Funds:
 

 
 

 
 

 
 

Equity Funds (1)
1,441

 

 

 
1,441

Fixed Income Funds (2)
485

 

 

 
485

Total
$
2,048

 
$
2,909

 
$

 
$
4,957

(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.
(2)
Mutual funds consist primarily of fixed income 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 Maine Water’s November 2015 bond offering, the Company recorded unused proceeds from this bond issuance as restricted cash as the funds can only be used for certain capital expenditures.  The Company used the remainder of the proceeds during 2016, as the approved capital expenditures were completed.  The carrying amount approximates fair value.  Under the fair value hierarchy the fair value of restricted cash is classified as a Level 1 measurement.

Long-Term Debt – The fair value of the Company’s fixed rate long-term debt is based upon borrowing rates currently available to the Company.  As of September 30, 2016 and December 31, 2015, the estimated fair value of the Company’s long-term debt was $227,369,000 and $191,616,000, respectively, as compared to the carrying amounts of $205,613,000 and $177,654,000, 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 a 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.

Advances for Construction – Customer advances for construction had a carrying amount of $20,175,000 and $21,444,000 at September 30, 2016 and December 31, 2015, respectively. Their relative fair values cannot be accurately estimated since future refund payments depend on several variables, including new customer connections, customer consumption levels and future rate increases.

20

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


The fair values shown above have been reported to meet the disclosure requirements of FASB ASC 825, “Financial Instruments” (“FASB ASC 825”) 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 Operations, Real Estate Transactions, and Services and Rentals. Financial data for the segments is as follows (in thousands):
Three months ended September 30, 2016
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense
 
Net Income
Water Operations
 
$
29,791

 
$
10,529

 
$
1,177

 
$
9,352

Real Estate Transactions
 
8

 
4

 
2

 
2

Services and Rentals
 
1,419

 
573

 
392

 
181

Total
 
$
31,218

 
$
11,106

 
$
1,571

 
$
9,535

Three months ended September 30, 2015
Segment
 
Revenues
 
Pre-Tax Income (Loss)
 
Income Tax Expense(Benefit)
 
Net Income
Water Operations
 
$
28,920

 
$
9,337

 
$
1,229

 
$
8,108

Real Estate Transactions
 
6

 
(9
)
 
(360
)
 
351

Services and Rentals
 
1,573

 
479

 
183

 
296

Total
 
$
30,499

 
$
9,807

 
$
1,052

 
$
8,755

Nine months ended September 30, 2016
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense
 
Net Income
Water Operations
 
$
78,022

 
$
23,652

 
$
2,010

 
$
21,642

Real Estate Transactions
 
8

 
4

 
2

 
2

Services and Rentals
 
3,862

 
1,673

 
691

 
982

Total
 
$
81,892

 
$
25,329

 
$
2,703

 
$
22,626

Nine months ended September 30, 2015
Segment
 
Revenues
 
Pre-Tax Income (Loss)
 
Income Tax Expense(Benefit)
 
Net Income
Water Operations
 
$
76,227

 
$
19,722

 
$
580

 
$
19,142

Real Estate Transactions
 
6

 
(9
)
 
(360
)
 
351

Services and Rentals
 
4,398

 
1,674

 
634

 
1,040

Total
 
$
80,631

 
$
21,387

 
$
854

 
$
20,533


The revenues shown in Water Operations above consisted of revenues from water customers of $29,477,000 and $28,444,000 for the three months ended September 30, 2016 and 2015, respectively. Additionally, there were revenues associated with utility plant leased to others of $314,000 and $476,000 for the three months ended September 30, 2016 and 2015, respectively. The revenues from water customers for the three months ended September 30, 2016 and 2015 include $81,000 and $1,111,000 in additional revenues related to the application of the WRA, respectively. The revenues shown in Water Operations above consisted of revenues from water customers of $77,084,000 and $75,098,000 for the nine months ended September 30, 2016 and 2015, respectively. Additionally, there were revenues associated with utility plant leased to others of $938,000 and $1,129,000 for the nine months ended September 30, 2016 and 2015, respectively. The revenues from water customers for the nine months ended September 30, 2016 and 2015 include $2,867,000 and $3,574,000 in additional revenues related to the application of the WRA, respectively.

The Company owns various small, discrete parcels of land that are no longer required for water supply purposes.  From time to time, the Company may sell or donate these parcels, depending on various factors, including the current market for land, the amount of tax benefits received for donations and the Company’s ability to use any benefits received from donations.

21

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


Assets by segment (in thousands):
 
September 30, 2016
 
December 31, 2015
Total Plant and Other Investments:
 
 
 
Water Operations
$
591,682

 
$
553,773

Non-Water
960

 
637

 
592,642

 
554,410

Other Assets:
 
 
 
Water Operations
174,115

 
154,090

Non-Water
3,069

 
2,215

 
177,184

 
156,305

Total Assets
$
769,826

 
$
710,715


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 beginning in the fourth quarter of 2013.  On March 24, 2015, the Company was notified by the Connecticut Department of Revenue Services that the audit was expanded to include the 2012 and 2013 tax years. The State focused its review on tax credits associated with fixed capital investment. The Company and the State came to an agreement (“Closing Agreement”) regarding investments eligible for the credit. The Closing Agreement was executed on May 4, 2015. The Company had previously recorded a provision for the possible disallowance of these credits and, therefore, there was minimal impact in 2015.

On the 2012 tax return, filed in September 2013, Connecticut Water filed a change in accounting method to adopt the Internal Revenue Service’s (“IRS”) temporary tangible property regulations. On the 2013 Federal tax return, filed in September 2014, Maine Water filed the same change in accounting method. 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. On February 11, 2014, the Company was notified by the IRS that its Federal tax filing for 2012 would be reviewed. This review, which began in the first quarter of 2014 and was completed in the first quarter of 2015, resulted in no change to the tax liability. Since the Company had previously recorded a provision for the possible disallowance of the repair deduction in prior periods, the completion of the audit resulted in the reversal of the provision in the amount of $1,185,000 in the first quarter of 2015. While the Company maintains the belief that the deduction taken on its tax return is appropriate, the methodology for determining the deduction has not been agreed to by the taxing authorities.  Through September 30, 2016, the Company has recorded, as required by FASB ASC 740, a provision of $1.7 million for a portion of the benefit that is not being returned to customers resulting from any possible tax authority challenge. The Company had previously recorded a provision of $6.3 million in the prior year for a cumulative total of $8.0 million.

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, 2016 and 2015.  Additionally, there were no accruals relating to interest or penalties as of September 30, 2016 and December 31, 2015.  The Company remains subject to examination by federal tax authorities for the 2013 through 2015 tax years; the State of Maine’s tax authorities for the 2013 through 2015 tax years; and the State of Connecticut’s tax authorities for the 2014 and 2015 tax years.


22

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The Company is currently engaged in an analysis to determine the amount of expenditures related to tangible property that will be reflected on its 2016 Federal Tax Return to be filed in September 2017.  As a result, through the third quarter of 2016, the Company has estimated the portion of its infrastructure investment that will qualify as a repair deduction for 2016 and has reflected that deduction in its effective tax rate, net of any reserves.  Consistent with other differences between book and tax expenditures, the Company is required to use the flow-through method to account for any timing differences not required by the IRS to be normalized.

The Company’s effective income tax rate for the three months ended September 30, 2016 and 2015 was 14.1% and 10.7%, respectively. The Company’s effective tax rate, excluding discrete items recorded during the three months ended September 30, 2016, was 7.0%. These discrete items include adjustments related to uncertain tax positions for the repair deduction in both Connecticut and Maine and a change in estimate of prior year tax expense. The blended Federal and State statutory income tax rates during each period were 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.

The Company’s effective income tax rate for the nine months ended September 30, 2016 and 2015 was 10.7% and 4.0%, respectively. The Company’s effective tax rate, excluding discrete items recorded during the nine months ended September 30, 2016, was 4.0%. These discrete items include adjustments related to uncertain tax positions for the repair deduction in both Connecticut and Maine and a change in estimate of prior year tax expense. The blended Federal and State statutory income tax rates during each period were 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.

10.
Lines of Credit

As of September 30, 2016, the Company maintained a $15.0 million line of credit agreement with CoBank, that is currently scheduled to expire on July 1, 2020.  The Company maintained an additional line of credit of $45.0 million with RBS Citizens, N.A., with an expiration date of April 25, 2021.  As of September 30, 2016, the total lines of credit available to the Company were $60.0 million.  As of September 30, 2016 and December 31, 2015, the Company had $21.8 million and $16.1 million, respectively, of Interim Bank Loans Payable. As of September 30, 2016, the Company had $38.2 million in unused lines of credit.  Interest expense charged on lines of credit will fluctuate based on market interest rates.

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, 2015.

General Information

Persistent dry weather and continued drought conditions in 2016 in the State of Connecticut recently prompted Connecticut Water to join other major water utilities in the state and request that all customers voluntarily reduce their water usage by 10% in July in an effort to extend the availability of existing supplies and to support the rivers and streams in the state. While supplies in our reservoirs are lower than normal, Connecticut Water also has groundwater sources in nearly all of its water systems that provide operational flexibility so we are not solely dependent on our reservoirs for water supply. Connecticut Water continues to encourage all customers to reduce their water usage by 10% and, in October, began asking customers in the shoreline communities of Guilford, Madison, Clinton, Westbrook and Old Saybrook to reduce their water usage by 15%. Connecticut Water will continue to monitor precipitation rates, reservoir levels, and water demands and will modify its request for water conservation measures accordingly. The Company anticipates that these actions will have no impact on water revenues given the availability of the Water Revenue Adjustment (“WRA”) mechanism discussed below.


23


Regulatory Matters

The rates we charge our water customers in Connecticut and Maine are established under the jurisdiction of and are approved by the Connecticut Public Utilities Regulatory Authority (“PURA”) and the Maine Public Utilities Commission (“MPUC”), respectively. 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 September 30, 2016, were 9.75% and 7.32%, respectively. Maine Water’s average allowed return on equity and return on rate base, effective September 30, 2016, were 9.50% and 7.96%, respectively. The PURA establishes rates in Connecticut on a company-wide basis while the MPUC approves Maine Water’s rates on a division-by-division basis. Both Connecticut Water and Maine Water are allowed to add surcharges to customers’ bills in order to recover certain approved capital projects in between full rate cases, as well as approved surcharges for Water Revenue Adjustments, as discussed in more detail below, in Connecticut.

Heritage Village Water Company Acquisition
On May 10, 2016, the Company entered into an Agreement and Plan of Merger (the “HVWC Agreement”) with Heritage Village Water Company, a specially-chartered Connecticut corporation (“HVWC”). Founded in 1969, HVWC is based in Southbury, Connecticut, and serves approximately 4,700 water and 3,000 waste water customers in the southern Connecticut communities of Southbury, Middlebury and Oxford.

The Boards of Directors of the Company and HVWC have each unanimously approved the HVWC Agreement. Consummation of the merger is subject to regulatory, HVWC shareholder and other specified approvals described below and is expected to be completed during either the fourth quarter of 2016 or the first quarter of 2017.

Under the terms of the HVWC Agreement, each share of HVWC common stock issued and outstanding at the time of the closing of the Merger will be exchanged and converted into the right to receive 240 shares of the common stock of the Company, without par value (the “Company Common Stock”), provided that the Company’s Share Price (as defined below) over a specified period prior to the closing date of the Merger is equal to or greater than $39.45 but less than or equal to $41.45. If the Company’s Share Price is less than $39.45 as of the closing date, each share of HVWC common stock issued and outstanding at the time of the closing of the Merger will be exchanged and converted into the right to receive that number of shares of Company Common Stock equal to $9,468 divided by the Company’s Share Price. If the the Company’s Share Price is more than $41.45 as of the closing date, each share of HVWC common stock issued and outstanding at the time of the closing of the Merger will be exchanged and converted into the right to receive that number of shares of the Company’s Common Stock equal to $9,948 divided by the Company’s Share Price. The “Company’s Share Price” is determined by calculating an average of the closing prices for shares of the Company’s Common Stock on the Nasdaq Stock Market, LLC for the twenty trading days immediately preceding the third business day prior to the closing of the Merger. Holders of HVWC common stock prior to the Merger will receive cash in lieu of fractional shares of Company Common Stock.

The HVWC Agreement contains customary representations and warranties regarding, on the one hand, HVWC, its business and operations and related matters, and, on the other hand, the Company, made by the parties as of specified dates, and customary affirmative and negative covenants with respect to the conduct of HVWC’s business prior to the closing. In the HVWC Agreement, HVWC has agreed that its Board of Directors will, subject to certain exceptions, recommend adoption of the HVWC Agreement by HVWC shareholders and the transactions contemplated by the HVWC Agreement. HVWC has also agreed: (i) to cause a special meeting of shareholders of HVWC to be held to consider the approval and adoption of the HVWC Agreement and the transactions contemplated thereby; and (ii) not to solicit proposals relating to alternative business combination transactions or, subject to certain exceptions, enter into discussions concerning confidential information in connection with alternative business combination transactions.

The obligation of the parties to complete the Merger is subject to the satisfaction or waiver on or prior to the closing date of certain specified conditions, including the following: (i) receipt of a final and non-appealable order of PURA approving the Merger in form and substance reasonably acceptable to the parties; (ii) approval of the Merger by the affirmative vote of the holders of not less than two-thirds (66 2/3rd%) of HVWC’s issued and outstanding shares of common stock as required under the Connecticut Business Corporation Act (“CBCA”) and by a super-majority vote of ninety (90%) percent of HVWC’s issued and outstanding shares; (iii) the completion of certain specified corporate governance steps regarding HVWC’s Board of Directors, including the appointment of up to three additional directors; (iv) the receipt of all other necessary consents or approvals to the Merger; (v) approval for listing of the Company Common Stock to be issued in the Merger on the Nasdaq Stock Market, LLC; (vi) the absence of laws, orders, judgments and injunctions that restrain, enjoin or otherwise prohibit consummation of the Merger; (vii) effectiveness under the Securities Act of 1933 (the “Securities Act”) of the Company’s registration statement on Form S-4 relating to the issuance of the Company Common Stock in the Merger and absence of any stop order in respect thereof or proceedings by the Securities and Exchange Commission (“SEC”) for that purpose; (viii) the receipt of customary tax opinions from counsel to HVWC and the Company that will state that the Merger will qualify as a tax-

24


free reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986; (ix) the accuracy of representations and warranties with respect to the businesses of HVWC and the Company and compliance by HVWC and the Company with their respective covenants contained in the HVWC Agreement; (x) no event(s) occurring that could reasonably be expected to result in a “Company Material Adverse Effect” (as defined in the HVWC Agreement) and (xi) holders of no more than 5% of HVWC’s common stock have exercised appraisal rights under Connecticut law.

The parties’ obligation to complete the Merger is also subject to a closing condition related to HVWC’s enabling legislation adopted in 1969. The special act of the Connecticut legislature that formed HVWC provides a right of first refusal (“ROFR”) to the Town of Southbury, Connecticut to purchase HVWC on the same terms and conditions as those set forth in the HVWC Agreement. The Town has a statutory period of ninety (90) days following receipt of notice from HVWC to exercise its right to purchase HVWC on such same terms and conditions. This notice was delivered to the Town on May 10, 2016.

On July 28, 2016, the Town of Southbury filed a lawsuit against HVWC and Connecticut Water in Connecticut state court seeking an injunction to preclude the parties from completing the merger or taking other actions that the Town believes will prevent the Town from fully enforcing its ROFR rights. On August 5, 2016, a hearing was held in Waterbury Superior Court at which the Court ordered that the Town’s ROFR deadline be extended to November 14, 2016. The Court’s order allows the Company to continue the approval process, with both state utility regulators and the SEC.

The HVWC Agreement contains certain termination rights for both the Company and HVWC and further provides that, in connection with the termination of the HVWC Agreement under specified circumstances, HVWC may be required to pay to the Company, or the Company may be required to pay to HVWC, a termination fee of $100,000 in cash, as liquidated damages.

On July 7, 2016, Connecticut Water filed an application with PURA seeking approval of the acquisition. PURA has issued interrogatories, to which the Company has responded, and held public hearings. Based on PURA’s schedule, the Company expects a decision t be rendered by PURA in December 2016.

Avon Water Company Acquisition
On October 11, 2016, the Company entered into an Agreement and Plan of Merger (the “Avon Agreement”) with The Avon Water Company, a specially-chartered Connecticut corporation (“Avon Water”). Founded in 1911, Avon Water serves about 4,800 customers in the Farmington Valley communities of Avon, Farmington, and Simsbury, Connecticut, and is located near Connecticut Water’s existing operations in Avon and Farmington.

The Boards of Directors of the Company and Avon Water have each unanimously approved the Avon Agreement and the transactions contemplated thereby. Consummation of the merger is subject to regulatory, Avon Water shareholder and other specified approvals described below and is expected to be consummated by the end of the first quarter of 2017.

Under the terms of the Avon Agreement, each of the 121,989 Avon Water common stock shares outstanding at the time of the closing of the merger will be exchanged and converted into the right to receive the following merger consideration: (i) a cash payment of $50.37; and (ii) a stock consideration component, consisting of 4.38 Company Common Stock, provided that the Company’s Share Price (as defined above) over a specified period prior to the closing date of the merger is equal to or greater than $45.00 but less than or equal to $52.00. If the Company’s Share Price is less than $45.00 as of the closing date, each share of Avon Water common stock issued and outstanding at the time of the closing of the merger will be exchanged and converted into the right to receive that number of shares of Company Common Stock equal to 197.10 divided by the Company’s Share Price, rounded to the nearest hundredth. If the Company’s Share Price is more than $52.00 as of the closing date, each share of Avon Water common stock issued and outstanding at the time of the closing of the merger will be exchanged and converted into the right to receive that number of shares of Company Common Stock equal to 227.76 divided by the Company’s Share Price, rounded to the nearest hundredth. Holders of Avon Water common stock prior to the Merger will receive cash in lieu of fractional shares of Company Common Stock.

The Avon Agreement contains customary representations and warranties regarding, on the one hand, Avon Water, its business and operations and related matters, and, on the other hand, the Company, made by the parties as of specified dates, and customary affirmative and negative covenants with respect to the conduct of Avon Water’s business prior to the closing. In the Avon Agreement, Avon Water has agreed that its Board of Directors will, subject to certain exceptions, recommend adoption of the Avon Agreement by Avon Water shareholders and the transactions contemplated by the Avon Agreement. Avon Water has also agreed: (i) to cause a special meeting of shareholders of Avon Water to be held to consider the approval and adoption of the Agreement and the transactions contemplated thereby; and (ii) not to solicit proposals relating to alternative business combination transactions or, subject to certain exceptions, enter into discussions concerning confidential information in connection with alternative business combination transactions.


25


The obligation of the parties to complete the merger is subject to the satisfaction or waiver on or prior to the closing date of certain specified conditions, including the following: (i) receipt of a final and non-appealable order of PURA approving the merger in form and substance reasonably acceptable to the parties; (ii) approval of the merger by the affirmative vote of the holders of not less than two-thirds (66 2/3rd %) Avon Water’s issued and outstanding shares of common stock as required under the CBCA; (iii) the receipt of all other necessary consents or approvals to the merger; (iv) approval for listing of the Company Common Stock to be issued in the merger on the Nasdaq Stock Market, LLC; (v) the absence of laws, orders, judgments and injunctions that restrain, enjoin or otherwise prohibit consummation of the Merger; (vi) effectiveness under the Securities Act of the Company’s registration statement on Form S-4 relating to the issuance of the Company Common Stock in the merger and absence of any stop order in respect thereof or proceedings by the SEC for that purpose; (vii) the receipt of a legal opinion from counsel to Avon Water regarding certain corporate law matters; (viii) the receipt of a customary tax opinion from counsel to the Company that will state that the merger will qualify as a tax-free reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986; (ix) the accuracy of representations and warranties with respect to the businesses of Avon Water and the Company and compliance by Avon Water and the Company with their respective covenants contained in the Avon Agreement; (xi) no event(s) occurring that could reasonably be expected to result in either a “Company Material Adverse Effect” or a “CWS Material Adverse Effect” (each, as defined in the Avon Agreement) and (xii) holders of no more than 5% of Avon Water’s common stock have exercised appraisal rights under Connecticut law.

The Avon Agreement contains certain termination rights for both the Company and Avon Water and further provides that, in connection with the termination of the Avon Agreement under specified circumstances, Avon Water may be required to pay to the Company, or the Company may be required to pay to Avon Water, a termination fee of $200,000 in cash, as liquidated damages.

During the fourth quarter of 2016, Connecticut Water expects to file an application with PURA seeking approval of the transaction.

Maine Water Land Sale
On March 11, 2016, Maine Water entered into a purchase and sale agreement with the Coastal Mountains Land Trust, a Maine nonprofit corporation (the “Land Trust”) pursuant to which Maine Water agreed to sell two conservation easements to the Land Trust on approximately 1,300 acres of land located in the towns of Rockport, Camden and Hope, in Knox County, Maine valued in the aggregate at $3.1 million.  The land had a book value of approximately $600,000 at December 31, 2015 and is included in “Utility Plant” on the Company’s “Consolidated Balance Sheets”. The easements and purchase prices are as follows:

1.Ragged Mountain Mirror Lake Conservation Easement: $1,875,000; and
2.Grassy Pond conservation Easement: $600,000.

The two easement sale and donation transactions are expected to close no later than December 31, 2017 and December 31, 2019, respectively.  Maine Water will make a $200,000 contribution to the Land Trust upon completion of the closing of the first easement sale.  Maine Water also expects to claim a charitable deduction for the $600,000 in excess of the fair market value of the second easement over the $600,000 sale price.

Connecticut Rates
In Connecticut, the Water Infrastructure Conservation Adjustment (“WICA”) was 3.04% and 5.12% at September 30, 2015 and 2016, respectively. On July 27, 2016, Connecticut Water filed a WICA application with the PURA requesting a 2.01% surcharge to customers’ bills, representing approximately $12.8 million in WICA related projects. On September 21, 2016, PURA approved the application as filed, effective October 1, 2016, the Company’s cumulative WICA surcharge was 7.13%. WICA surcharges are capped at 10% between general rate cases.

Since 2013, Connecticut law has authorized a Water Revenue Adjustment (“WRA”) to reconcile actual water demands with the demands projected in the last general rate case and allows companies to adjust rates as necessary to recover the revenues approved by PURA in the last general rate case. The WRA removes the financial disincentive for water utilities to develop and implement effective water conservation programs. The WRA allows water companies to defer on the balance sheet, as a regulatory asset or liability, for later collection from or crediting to customers the amount by which actual revenues deviate from the revenues allowed in the most recent general rate proceedings, including WICA proceedings. Additionally, projects eligible for WICA surcharges were expanded to include energy conservation projects, improvements required to comply with streamflow regulations, and improvements to acquired systems.

Connecticut Water’s allowed revenues for the nine months ended September 30, 2016, as approved by PURA during our 2010 general rate case and including subsequently approved WICA surcharges, are approximately $59.1 million. Through normal

26


billing for the nine months ended September 30, 2016, revenue for Connecticut Water would have been approximately $56.2 million had the WRA not been implemented. As a result of the implementation of the WRA, Connecticut Water recorded $2.9 million in additional revenue for the nine months ended September 30, 2016.

Maine Rates
In Maine, the overall, cumulative Water Infrastructure Charge (“WISC”) for all divisions was 1.13% and 4.08% as of September 30, 2015 and 2016, respectively.

In 2014 and 2015, Maine Water petitioned the MPUC for approval of accounting orders that would address (1) the return to its customers a federal income tax refund stemming from the adoption of the Internal Revenue Service (“IRS”) Revenue Procedure 2012-19 (“Repair Regulations”), and (2) the treatment of any benefit resulting from the elimination of deferred tax liabilities previously recorded on these qualifying fixed assets that are now deducted under the Repair Regulations.

On February 26, 2015, the MPUC approved a stipulation between Maine Water and the Office of the Public Advocate that refunds $2.9 million to the customers of the eight divisions over a two-year period starting no later than July 1, 2015, and allows the flow-through treatment of the repair deduction as of January 1, 2014. In addition, Maine Water agreed not to file a general rate case during the two-year refund period in any of the eight divisions that were allowed the refund.

On June 22, 2015, the MPUC approved a settlement agreement between Maine Water and the Office of the Public Advocate that allowed for the amortization of the deferred tax liabilities over a one to nine year period, depending on the division. Maine Water commenced amortization per the agreed upon schedule.

With the completion of these two dockets, Maine Water recorded in the quarter ended June 30, 2015 the retroactive benefit associated with the flow-through of the Repair Regulations from January 1, 2014. The 2014 benefit, reflected in the second quarter of 2015, was approximately $931,000, or $0.09 per basic share outstanding.

A newly passed water revenue adjustment mechanism law in Maine became available to regulated water utilities in Maine on October 15, 2015. Maine Water is currently precluded from seeking new rates in a majority of its divisions until after June 2017 due to various agreements with the MPUC, but is evaluating how and when this new mechanism can be implemented.

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 and Maine Water, 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, 2015.

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 WRA), goodwill impairment, income taxes 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, 2015.

During the preparation of the Condensed Consolidated Financial Statements for the quarter ended June 30, 2016, the Company identified two errors related to the accounting treatment of stock-based performance awards granted to officers of the Company. First, the Company had mistakenly classified all stock-based performance awards as equity awards and, secondly, incorrectly marked those awards to the market price of the Company’s common stock price at the end of each reporting period. A portion of these awards should have been classified as liability awards and only those awards should have been marked-to-market based on the Company’s common stock price. During the second quarter of 2016, the Company reversed all of the incorrectly recorded mark-to-market expense as a cumulative out-of-period adjustment resulting in a one-time benefit of approximately $2.6 million on the Operation and Maintenance line item on its Condensed Consolidated Statements of Income for the three months ended June 30, 2016 and $1.6 million for the six months ended June 30, 2016. Approximately $1.6 million of the out of period adjustment pertained to years prior to 2016, with the remaining $1.0 million related to the first quarter of 2016. Additionally, the Company decreased its Common Stock Without Par Value and increased its Long-Term Compensation Arrangement line items on the Condensed Consolidated Balance Sheet as of June 30, 2016 by approximately $0.6 million to reflect both the awards that should have been classified as liability awards and their corresponding mark-to-market adjustments.

27



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 2015 Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

The Company’s earnings and profitability are primarily dependent upon the sale and distribution of water. In Maine, water revenues can be dependent on seasonal weather fluctuations, particularly during the summer months when water demand will vary with rainfall and temperature levels. This risk has been mitigated in Connecticut with the implementation of the WRA. The Company’s earnings and profitability in future years will also depend upon a number of other factors, such as the ability to control our operating costs, 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, and the timing and adequacy of rate relief when requested, from time to time, by our regulated water companies.

The Company expects Net Income from its Water Operations segment to increase in 2016 over 2015 levels, primarily due to revenue increases due to expected rate increases and the utilization of WISC in Maine and WICA in Connecticut, continued cost containment efforts and modest growth in its Services and Rentals segment. The Company currently does not expect to complete any Real Estate transactions during the year ending December 31, 2016.

The Company believes that the factors described above and those described in detail 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 2016 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, 2015 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

As of September 30, 2016, the Company maintained a $15.0 million line of credit agreement with CoBank, that is currently scheduled to expire on July 1, 2020.  The Company maintained an additional line of credit of $45.0 million with RBS Citizens, N.A., with an expiration date of April 25, 2021.  As of September 30, 2016, the total lines of credit available to the Company were $60.0 million.  As of September 30, 2016 and December 31, 2015, the Company had $21.8 million and $16.1 million, respectively, of Interim Bank Loans Payable. As of September 30, 2016, the Company had $38.2 million in unused lines of credit.  Interest expense charged on lines of credit will fluctuate based on market interest rates.

On March 17, 2015, Maine Water completed the issuance of $1,864,050 aggregate principal amount of its First Mortgage Bonds, Series Q, 0.01% due March 17, 2035 (the “Series Q Bonds”). The Series Q Bonds were issued by Maine Water to the Bank and the proceeds of the issuance were loaned (the “Series Q Loan”) by the Maine Municipal Bond Bank (the “Bank”) to Maine Water pursuant to a Loan Agreement by and between Maine Water and the Bank dated as of March 17, 2015. The proceeds of the Series Q Loan were used by Maine Water to fund various water facilities projects, including the replacement of a booster station and modifications to a treatment plant, each located in the City of Biddeford, Maine.

On November 25, 2015, Maine Water completed the issuance of $2,487,630 aggregate principal amount of its First Mortgage Bonds, Series R, 1.0% due November 25, 2025 (the “Series R Bonds”). The Series R Bonds were issued by Maine Water to the Bank and the proceeds of the issuance were loaned (the “Series R Loan”) by the Bank to Maine Water pursuant to a Loan Agreement by and between Maine Water and the Bank dated as of November 25, 2015. The proceeds of the Series R Loan were used by Maine Water to fund the construction of a 3 million gallon water storage tank, located in the City of Biddeford, Maine, which replaced an existing in-ground 7.5 million gallon reservoir.


28


In April 2016, Connecticut Water filed an application with PURA to issue promissory notes in the aggregate principal amount of up to $49,930,000 with CoBank, ACB (“CoBank”) under its existing Master Loan Agreement by and between Connecticut Water and CoBank dated October 29, 2012, in order for Connecticut Water to redeem its $19,930,000 2009A Series of outstanding Water Facility Revenue Bonds previously issued by the Connecticut Development Authority (the “2009A Bonds”) and to provide $30,000,000 to partially fund its ongoing construction program. On June 1, 2016, Connecticut Water issued $30,000,000, at 4.36%, in debt under its existing Master Loan Agreement with CoBank, with a maturity date of May 20, 2036. On July 7, 2016, Connecticut Water issued $19,930,000, at 4.04%, in debt under its existing Master Loan Agreement with CoBank, with a maturity date of July 7, 2036. Connecticut Water used the proceeds to immediately pay of the the $19,930,000 2009A Series of outstanding Water Facility Revenue Bonds.

In addition to paying off the 2009 A Series, Due 2039 using the proceeds of the July CoBank issuance discussed above, during the first nine months of 2016, the Company paid approximately $772,000 related to Connecticut Water Service’s Term Note Payable issued as part of the 2012 acquisition of Maine Water and approximately $905,000 in sinking funds related to Maine Water’s outstanding bonds.

Credit Rating

On February 11, 2016, Standard & Poor’s Ratings Services (“S&P”) affirmed its ‘A’ corporate credit rating on the Company. Additionally, S&P also affirmed the Company’s ratings outlook as stable.

Stock Plans

The Company offers a dividend reinvestment and stock purchase plan (“DRIP”) for all registered shareholders and for the customers and employees of our regulated water companies, whereby participants can opt to have cash 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 which is intended to encourage greater shareholder, customer and employee participation in the DRIP. In August 2014, the Board of Directors approved further amendments to the DRIP to reflect the Company’s appointment of a new common stock transfer agent. During the nine months ended September 30, 2016 and 2015, plan participants invested $1,232,000 and $1,134,000, respectively, in additional shares as part of the DRIP.

2016 Construction Budget

The Board of Directors approved a $65.9 million construction budget for 2016, net of amounts to be financed by customer advances and contributions in aid of construction.  The Company will use a combination of its internally generated funds, borrowing under its available lines of credit and proceeds from recently completed debt issuances.

As the Company looks forward to the remainder of 2016 and 2017, it anticipates continued reinvestment to replace aging infrastructure and to seek recovery of these costs through periodic WICA and WISC applications.  The total cost of that investment may exceed the amount of internally generated funds.  The Company expects to rely upon its internally generated funds and short-term borrowing facilities and proceeds from recently completed debt issuances.

Results of Operations

Three months ended September 30
Net Income for the three months ended September 30, 2016 increased from the same period in the prior year by $780,000 to $9,535,000. Earnings per basic average common share were $0.86 and $0.80 during the three months ended September 30, 2016 and 2015, respectively.

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

Business Segment
 
September 30, 2016
 
September 30, 2015
 
Increase/(Decrease)
Water Operations
 
$
9,352

 
$
8,108

 
$
1,244

Real Estate Transactions
 
2

 
351

 
(349
)
Services and Rentals
 
181

 
296

 
(115
)
Total
 
$
9,535

 
$
8,755

 
$
780


29



See the discussion below for details on the increase in the Water Operations Net Income:

Revenue

Revenue from our water customers increased by $1,033,000, or 3.6%, to $29,477,000 for the three months ended September 30, 2016 when compared to the same period in 2015.  The primary driver for this increase was due to higher WISC and WICA surcharges in Maine and Connecticut, respectively.

Operation and Maintenance Expense

Operation and Maintenance (“O&M”) expense decreased by $690,000, or 5.7%, for the three months ended September 30, 2016 when compared to the same period of 2015. The following table presents the components of O&M expense for the three months ending September 30, 2016 and 2015 (in thousands):

Expense Components
 
September 30, 2016
 
September 30, 2015
 
Increase / (Decrease)
Mark-to-market
 
$
(72
)
 
$
375

 
$
(447
)
Pension
 
780

 
1,096

 
(316
)
Outside services
 
838

 
1,043

 
(205
)
Maintenance
 
824

 
950

 
(126
)
Post-retirement medical
 
109

 
184

 
(75
)
Customer
 
354

 
421

 
(67
)
Vehicles
 
352

 
416

 
(64
)
Payroll
 
3,893

 
3,954

 
(61
)
Investor relations
 
149

 
165

 
(16
)
Water treatment (including chemicals)
 
790

 
777

 
13

Utility costs
 
1,029

 
1,013

 
16

Property and liability insurance
 
395

 
373

 
22

Purchased water
 
616

 
469

 
147

Other benefits
 
640

 
230

 
410

Medical
 
614

 
357

 
257

Other
 
184

 
362

 
(178
)
Total
 
$
11,495

 
$
12,185

 
$
(690
)

The changes in individual items are described below:
Due to the errors in calculating mark-to-market expense that were corrected in the second quarter of 2016, there are considerably fewer shares that were marked-to-market than in the three months ended September 30, 2016 when compared to the same period of 2015. The reduction to O&M expense in the three months ended September 30, 2016 relates to the decrease in the Company’s stock price between June 30, 2016 and September 30, 2016;
Pension and post-retirement medical costs decreased primarily due to an increase in the discount rate used in determining 2016 expense compared to the discount rate used to determine the 2015 expense;
Outside services decreased primarily due to a reduction in costs associated with outside contractors and consultants;
Customer costs decreased primarily due to a reduction in customer communications in the third quarter of 2016 when compared to the same period of 2015 and a decrease in legal collection fees. These decreases were partially offset by costs associated with a new voluntary water conservation program that rewards customers for reducing their 2016 consumption by 10% compared to their 2015 consumption;
Payroll costs decreased primarily due to an increase in the amount of employee time charged to capital projects in the period ended September 30, 2016; and
Investor relations costs decreased primarily due to a reduction in directors fees due to the retirement of a member of the Board of Directors and a reduction in costs associated with an investor relations consultant during the period ending September 30, 2016.

The decreases described above were partially offset by the following increases to O&M expense:
Medical costs increased primarily due to an increase in claims made by employees and their families;

30


Other benefits increased primarily due to costs associated with the Company’s performance stock plans; and
Purchased water costs increased primarily due to an increase in the amount of water purchased from neighboring utilities, particularly in the Company’s Shoreline Region in Connecticut which has experienced continuing drought conditions during 2016.

The Company saw an approximate $220,000, or 6.8%, increase in its Depreciation expense from the three months ended September 30, 2016 compared to the same period in 2015.  The increase was primarily due to higher Utility Plant in Service as of September 30, 2016 compared to September 30, 2015 driven by spending on WICA and WISC projects in Connecticut and Maine, respectively.

Other Income (Deductions), Net of Taxes decreased for the three months ended September 30, 2016 by $345,000. The primary driver of this decrease was the reduction in Gain on Real Estate Transactions during the three months ended September 30, 2016 related to a land donation which generated tax benefits in the third quarter of 2015, compared with a small land sale during the same period in 2016. Partially offsetting this decrease was an increase in Allowance for Funds Used During Construction (“AFUDC”) during 2016 due primarily to an increase in the monthly balances of Construction Work in Progress through September 30, 2016 when compared to the same period in 2015 as a result of the ongoing construction of a major treatment plant in Connecticut.

Total Interest and Debt Expense increased by $105,000 in the three months ended September 30, 2016 when compared to the same period in 2015. The primary reason for the increase in Interest and Debt Expense was the result of higher debt balances outstanding at September 30, 2016 when compared to September 30, 2015.

Nine months ended September 30
Net Income for the nine months ended September 30, 2016 increased from the same period in the prior year by $2,093,000 to $22,626,000. Earnings per basic average common share increased by $0.18 to $2.05 during the nine months ended September 30, 2016.

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

Business Segment
 
September 30, 2016
 
September 30, 2015
 
Increase/(Decrease)
Water Operations
 
$
21,642

 
$
19,142

 
$
2,500

Real Estate Transactions
 
2

 
351

 
(349
)
Services and Rentals
 
982

 
1,040

 
(58
)
Total
 
$
22,626

 
$
20,533

 
$
2,093


The Net Income from Water Operations for the nine months ended September 30, 2016 and 2015 were each impacted positively by non-recurring items. During the nine months ended September 30, 2016, the Company reversed incorrectly recorded mark-to-market expense as an out-of-period adjustment resulting in a one-time benefit (reduction) of approximately $1.6 million in Operation and Maintenance expense. Approximately $1.6 million of the out of period adjustment pertained to years prior to 2016, with the remaining $1.0 million related to the first quarter of 2016. During the nine months ended September 30, 2015, the Company recorded an approximate $2.1 million reduction to Income Tax expense related to a June 2015 MPUC approval of a settlement agreement between Maine Water and the State of Maine’s Office of Public Advocate that in part allowed for the flow through benefit of Maine Water’s adoption of the IRS’s Repair Regulations and the reversal of previously established reserves after the completion of an IRS audit of the Company’s 2012 federal tax return. The items discussed in detail below reflect the approximate $2.6 million increase in Net Income during the nine months ended September 30, 2016 after the impact of the above non-recurring items.

Revenue

Revenue from our water customers increased by $1,986,000, or 2.6%, to $77,084,000 for the nine months ended September 30, 2016 when compared to the same period in 2015.  The Company saw an increase in revenues in Maine due to rate increases in certain Maine Water divisions through regular rate increases and WISC surcharges and increased WICA surcharges in Connecticut.


31


Operation and Maintenance Expense

O&M expense decreased by $3,064,000, or 8.8%, for the nine months ended September 30, 2016 when compared to the same period of 2015. The following table presents the components of O&M expense (in thousands):

Expense Components
 
September 30, 2016
 
September 30, 2015
 
Increase / (Decrease)
Mark-to-market
 
$
(1,465
)
 
$
24

 
$
(1,489
)
Pension
 
2,322

 
3,287

 
(965
)
Outside services
 
2,238

 
2,774

 
(536
)
Maintenance
 
2,351

 
2,578

 
(227
)
Payroll
 
11,612

 
11,831

 
(219
)
Post-retirement medical
 
329

 
545

 
(216
)
Utility costs
 
2,899

 
3,014

 
(115
)
Vehicles
 
1,132

 
1,181

 
(49
)
Water treatment (including chemicals)
 
2,045

 
2,074

 
(29
)
Property and liability insurance
 
1,114

 
1,129

 
(15
)
Customer
 
1,263

 
1,115

 
148

Purchased water
 
1,281

 
1,132

 
149

Medical
 
1,989

 
1,694

 
295